Managing Credit/Debt

Since I’ve started working my expenses have increased greatly. Most of these expenses I think are necessary. Since I was living very meagerly before it was almost impossible for me to not experience some lifestyle inflation. I don’t really consider this to be a bad thing though. For instance I spent almost $900 last month for oral surgery. This was something I had put off for a long time but definitely needed to be done. Also I am now paying for health insurance. Having health insurance is an increase of lifestyle over not having health insurance but one that I consider reasonable.

Other expenses are less clear. I signed up for the SERO plan from Sprint.  This will mean a monthly phone bill of $30 plus tax. This is considerably more than the roughly $10 a month phone bill I had before. I think it is worth it since I can now talk to my family and friends as long as I like without worrying about per-minute charges. It isn’t a necessary expense though and I need to be careful about adding too many similar expenses to my budget. I’m satisfied that my expenses are still reasonable for my income now but I know I need to monitor them to make sure they don’t get unreasonable. For more about lifestyle inflation here are a couple of posts I found informative.

“Lifestyle Inflation-When Does It Become a Problem“  from Money,Matter, and More Musings.

“How to Protect Yourself from Lifestyle Inflation” from Get Rich Slowly.

It doesn’t seem like I am making any progress on paying off my debt or building up my emergency fund. Last month I only paid $100 on my debt and contributed just $25 towards my emergency fund. There were a lot of extraordinary one-time expenses last month but I know there will always be unusual expenses. I guess I just need to be patient and stick to my plan. I know I will do significantly better on paying down my debt and building up my emergency fund this  month.

A couple weeks ago I asked what I should do with my money. I received several suggestions and took them into consideration when making my decision. This is what I’ve decided to do for now. I’m getting health insurance first. I’m also going to open a Roth IRA and contribute $50 a month. With my surplus money, which should be a few hundred dollars, I’m going to put half towards my emergency fund and half towards debt repayment. When the emergency fund is fully funded I’ll divide the surplus between debt and fully funding the IRA.  I may temporarily put more towards debt repayment to make sure my credit card is paid off before the 0% balance transfer offer ends.

Now that I finally have a little income I need to figure out what to do with it. There are several things I would like to do with my money but I can’t do them all at once. The things I would like to do are:

• pay off my credit card (approx. $1600 balance)
• establish $1000 emergency fund
• open a Roth IRA
• get health insurance

Getting health insurance should probably be my first priority, after that it is less clear. My credit card is at 0% interest but that will end in August. The interest rate will then be 11.74%. I know it would be smarter financially to pay off the card then keep $1000 in a savings account earning 5% but I like the idea of having a little cushion in the bank. I’ve already delayed opening a Roth IRA for too long. I am almost 40 and have no retirement savings. That is why I want to get the IRA started soon. So far I haven’t done anything because I can’t make up my mind. Do you have any suggestions?

You can’t borrow your way out of debt. That saying is true but smart borrowing can speed up the debt repayment process. Moving your debt from a high interest rate to a lower interest rate will allow you to pay off the debt quicker and reduce the overall amount of interest you pay. Of course it isn’t as easy as some debt consolidation companies would like you to believe. There are pitfalls in this process to look out for.

Here is an example of how I switched high interest debt for low interest debt. I have a private student loan with an interest rate of 11.75%. The interest rate is variable so it could go up even more. I took out a Grad Plus loan at 8.25%(fixed) and applied the proceeds of that loan against the 11.75% loan.

The mistake I made in doing this was not immediately applying the new loan to the old loan. The new loan was for a total of $15,200 disbursable in two amounts of $7600 (one for fall semester and one for winter semester). After leaving this in my bank account for a couple months I realized that I had been spending my money too freely and had used part of the new loan proceeds for my current spending. I ended up using about $2000 of the new loan money for current expenses rather than for paying on the old loan. Luckily, I was able to make up the $2000 this semester but it left me with much less money to live on for this semester. Also since the old loan was larger than the new loan I still don’t have it completely paid off. I plan to do that over the summer.
This is possibly the biggest pitfall of trying to borrow your way out of debt. If you don’t use the new money to pay off the old debt you will just end up even deeper in debt. Paying off a credit card and charging it up again is basically the same thng. Another thing to look out for is that you don’t extend the payment term on the debt. If you end up paying the debt off over a much longer time period you could pay even more interest than before despite having a lower interest rate.

These are things to look for if you are thinking about borrowing money to help your debt repayment process. If you’re not sure that you have the discipline to avoid these pitfalls than you should probably not borrow any more money.