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Reduce Debt Using The Debt Snowball Method

debt snowball

Remember as a kid when it would snow, and you couldn’t wait to get out and build a snowman? How it took a bit of effort to get that snowball started, but soon it began gathering momentum, getting bigger faster and faster? Debt reduction works in much the same way…and when all your debt is paid off, you’ll feel just as giddy as you did when you were little.

How The Debt Snowball Method Works

The debt snowball method is a debt reduction strategy where you pay off your debt starting with the smallest bills and progressing to the larger ones, regardless of the interest rate. Once you’ve paid your smallest debt in full, you take the money you were paying on that debt for the next smallest balance. As you do this over and over, you gain more momentum with each one – like a snowball getting bigger and bigger as rolls.

Six Steps To Debt Reduction

  1. With the exception of your mortgage, list all your debts from smallest to largest. This is determined by the amount owed, not the interest rate. However, if two debts are really close in amount, list the higher interest rate one first.
  2. Pay the minimum amount on every debt except the smallest one.
  3. Determine how much extra you can apply to the smallest debt.
  4. Pay the minimum payment, plus the extra amount on your smallest debt until it is paid in full. (note, for some loans such as car loans, you should contact the lender to inform them that the extra amount should go towards principal – not just the next payment which includes interest).
  5. Once the first debt is paid in full, add the minimum payment of the next smallest debt, plus any additional funds, to the next smallest debt.
  6. Repeat until all debts are paid in full!

Example of the Debt Snowball

Let’s say you have the following four debts you need to pay off:

  1. $2,000 credit card debt – $40 minimum payment.*
  2. $5,000 student loan – $59 minimum payment.**
  3. $7,500 credit card debt – $150 minimum payment.*
  4. $12,000 car loan – $232 minimum payment.***

Using the debt snowball method, you would pay the minimum amount on each debt except the $2,000 credit card payment. Let’s say you have an extra $500 a month to put towards that first debt. Combining the extra $500 with your minimum payment of $40 for a total payment of $540 means you’ll pay that baby off in 4 months.

Now, you’ll take that $540 from your credit card debt and add it to the $59 minimum payment on your student loan. By paying $599 each month on your student loan, you’ll be able to say “Adios” to your remaining student debt in 9 months!

Next, you’ll add that $599 to second credit card’s minimum monthly payment of $150, for a total of $749. Now you’re saying “Sayonara” to the rest of your credit card debt in 11 months…Wahoo!!! With 3 down and 1 to go, you’re really rolling (see the snowball reference there?)!

By the time you start paying more than the minimum on your car loan, you’re able to add $749 to your minimum monthly payment of $232. At $981 total per month, your car loan will be paid off in full in 9 months. Thanks to your commitment and focus, you’re debt free in 33 months!

Why It Works

The reason the debt snowball method works has less to do with math and more to do with the psychological benefit of seeing results sooner. By paying the smallest debts first, you’ll see fewer bills as they’re paid off which gives ongoing positive feedback toward the progress of eliminating debt. A 2012 study by Northwestern’s Kellogg School of Management[1] found that “consumers who pursued the “small victories” strategy was more likely to eliminate their entire debt balance” than trying to pay off their high-interest rate credit card first.

A study in the Harvard Business Review[2] showed similar results. Participants who were asked to concentrate on making payments to a single account vs. dispersing them across many showed higher motivation, repaying their debt more quickly.

Choose The Plan That Works For You

While paying off your debts in order of highest to lowest interest rate may be cheaper or faster, if it’s a plan you abandon, then it won’t work. If achieving subgoals (like with the debt snowball method) can help you stick to your plan of reducing or eliminating your debt, it is worth the extra you may pay in interest.

Disclaimer: The information contained herein is general in nature and based on authorities that are subject to change. Churchill Mortgage guarantees neither the accuracy or completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Churchill Mortgage assumes no obligation to inform the reader of any changes that could affect information contained herein. This publication does not, and is not intended to, provide legal, financial, tax or accounting advice, and readers should consult their advisors concerning the application of tax laws to their particular situations.
1.  http://www.kellogg.northwestern.edu/news_articles/2012/snowball-approach.aspx
2. “Research: The Best Strategy for Paying Off Credit Card Debt“. Harvard Business Review.
*Assumes APR of 15.6%
**Assumes APR of 5.05% over 10 years
***Assumes APR of 6% over 5 years

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5 Easy Steps To An Effective Budget

budget

Ah, the “b” word. Nope, not that one…the other one. The one that conjures up images of spreadsheets, endless calculations and potentially, hair pulling. Yep, that’s it … budget! Sadly, it’s this kind of vision that has folks avoiding the work involved in the most effective tool you can use to take control of your money! Its bad rep of boredom and sacrifice overshadow the amazing benefits of having one.

When you create a basic budget and stick to it, it will suddenly seem like you have more money. ~Dave Ramsey

A budget gives you the freedom to choose how you spend and invest your money. And, with the amazing technology we have available today, maintaining a budget is easier than ever!

Follow these 5 easy steps and you’ll be well on your way to controlling your finances!

1. Determine Your After-Tax Income

This amount is your total take-home pay, after Uncle Sam takes his cut, of course. Besides a regular salary, you should include any other income that comes your way during the year. This could include a side hustle, alimony, child support, interest, dividends, social security, year-end bonus, etc.

Have any automatic deductions like a 401(k), savings or insurance? Be sure to account for them so you have an accurate picture of your income and expenditures. If you’re married or have a significant other that you share expenses with, include their income as well.

2. Calculate Your Expenses

This is where the fun really begins! Grab your bank & credit card statements and any other financial files you keep…and possibly a can your favorite energy drink. While most of your expenses are monthly, some may occur only quarterly or annually, so using 6-12 months’ worth of statements can help you get the most accurate financial picture.

List all your expenses – we’ve included a Personal Budget Template to help you get started. Depending on your budgeting experience, or enthusiasm for details, you can either:

  • Get an average monthly expense by adding up everything you’ve spent in the last 6-12 months and dividing it by the number of months.
  • Break out your expenses by month. For instance, if your HOA fee is paid the first month of every quarter, you only have to include this item in your budget as an expense for January, April, July and September.

3. Subtract Expenses From Income

Your budget should account for every dollar. Although possible, it’s not likely that your expenses will match your income exactly. If your expenses are greater than your income, revisit your budget and see where you can make some cuts. If your income is greater than your expenses, you’ll want to account for those remaining dollars. You could start an emergency fund, pay down debt, invest them in retirement, etc. Just give them a home or they’ll find one of their own.

4. Budget Adjustments

Are you putting your money where your priorities are? Once you’ve taken a look at where you’ve been spending your money, you can make any necessary adjustments to create a budget that reflects your financial priorities. Let’s say after reviewing last year’s expenses you’re surprised to learn that the $5 coffee you grab on the way to work every morning is costing you $1,250 a year…YIKES! What if you got coffee only twice a week and put the $750 you’re saving towards your monthly debt? Or better yet, what if you make your coffee at home every day and saved the entire $1,250?

5. Record & Track Your Spending

Now that you’ve created this beautiful work of art (yep, we’re still talking about your budget), it’s time to put it to good use! Decide whether you want to use technology or take a DIY approach to your budget. If you decide to go the technology route, having software that links to your accounts, downloads all your transactions and categorizes them can be a great time saver. If you’re not comfortable with having your accounts linked to your budget software, using a spreadsheet or good old pencil and paper are still great options!

Review your budget at least once a month to see what money is coming in, how quickly you’re spending it and what you’re spending it on.

Life Happens, Be Realistic

Remember to be realistic about your budget. If you fall off the wagon once and a while, hop back on as soon as you can. If you stick to your budget the majority of the time, you’ll be successful in reaching your financial goals!

The information contained herein is general in nature and based on authorities that are subject to change. Churchill Mortgage guarantees neither the accuracy or completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Churchill Mortgage assumes no obligation to inform the reader of any changes that could affect information contained herein. This publication does not, and is not intended to, provide legal, financial, tax or accounting advice, and readers should consult their advisors concerning the application of tax laws to their particular situations.

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Get Debt Free Using A Debt Consolidation Refinance

debt consolidation refinance

When our clients Jay and Lisa called us a few months ago they were on pace to pay off their mortgage within 12 years. There was just one little catch… at over $200,000, their consumer debt was out of control. As Dave Ramsey followers, they knew they had to address this if they were going to create a better financial future for themselves. They came to us asking “If we’re already in our mid 40’s, how are we going to pay off all this debt so we can enjoy our retirement years?”

We helped them create a debt consolidation refinance plan so they could to tap into the idle equity in their home and pay off their consumer debt. They took out a new first mortgage to pay off their current first and second mortgage as well as their credit card debt and two car loans. Now they’re taking that monthly savings and adding it to their student loan payments to pay them off even faster. In 4.5 years, when these are paid off, they’ll take that student loan payment and apply it to their mortgage. In just over 12 years, they’ll be completely debt free – that’s 5 years sooner than on their previous path!

Benefits of A Debt Consolidation Refinance

While consumer debt continues to increase in the US, so does home equity. Although Core Logic’s Home Equity Report(1) shows that home equity grew in almost every state, Colorado was in the top 10! We showed a significant increase – gaining an average of $17,000 per borrower last year.

If you’ve been considering a debt consolidation refinance, now may be the time to act. For folks who are disciplined with their money, this can be a great financial planning tool. By consolidating your high-interest debt into your monthly mortgage payment, you could reduce your average interest rate, your total monthly debt expense and pay less interest overall.

Though it can be a great option, consolidating credit card and other debt into your mortgage is not right for everyone. Consider these 5 questions before deciding whether it’s an appropriate choice for you.

1. How Much Equity Is in Your Home?

If you’re thinking about a debt consolidation refinance, you’ll need to be sure you have enough equity in your home. Your loan-to-value (LTV) ratio should be less than 80% after completing your refinance. To roughly calculate the potential LTV of a new loan, divide your current mortgage balance plus the cash out desired by the approximate value of your home. For example:

current mortgage: $250,000 + cash out: $100,000/approx home value: $500,000 = 70% LTV

2. Which Loans Will You Pay Off?

If you’re looking to pay off multiple loans with this debt consolidation refinance, keep in mind that depending on the amount of equity you have available, it may not be possible to pay off everything. In this situation, how do you determine which debts to pay off? Typically, we recommend paying off the loan with the highest interest rate first. However, you should also take into consideration the monthly payment, length of the loan and total interest expense. Longer term loans may end up costing you more in interest over the long haul, even if the interest rate is lower.

Keep in mind that refinancing doesn’t really pay off anything, it just moves your debt around.

3. How Will You Avoid Running Up Debt Again?

One of the biggest challenges after paying off debt? Not racking it right back up! If debt has been an issue for you, work on changing your spending habits first. Set a budget and get a sense of how much disposable income you actually have. Otherwise, you’ll end up back in the same situation in the near future, and this time your home could be at stake.

4. What Additional Costs Will You Pay?

A debt consolidation refinance (or cash-out refinance) carries the typical costs of a traditional refinance, such as closing costs, title fees, appraisal fees, etc. This type of loan also has a slightly higher interest rate; about .25% to .375% depending on factors like credit score and your new LTV. Be sure to factor these expenses in when determining if a cash-out refinance makes sense for you.

5. Are You Willing to Put Your Home on the Line?

Last, but certainly not least … a debt consolidation refinance takes high-interest, unsecured debt and rolls it into a mortgage secured by your home. If you’re struggling with personal debt to the point where you are or might consider bankruptcy, this is not a choice for you. If you lose your job or take out a refinancing loan that you can’t afford, you are much more likely to lose your house than if you were to declare bankruptcy due to excessive personal debt. 

Bottom Line: Don’t refinance debt into a mortgage you can’t afford.

What Are Your Next Steps?

If you think a debt consolidation refinance is in your future, give us a call today and we’ll help you determine if it’s the right fit for you.

The information contained herein is general in nature and based on authorities that are subject to change. Churchill Mortgage guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Churchill Mortgage assumes no obligation to inform the reader of any changes that could affect information contained herein. This publication does not, and is not intended to, provide legal, financial, tax or accounting advice, and readers should consult their advisors concerning the application of tax laws to their particular situations.
1. https://www.corelogic.com/news/corelogic-reports-homeowners-with-negative-equity-increased-by-35000-in-the-fourth-quarter-of-2018.aspx

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Smart Ways to Spend Your Tax Refund

Tax Refund

As of April 12th, the average taxpayer who has received a tax refund in 2019 will receive a $2,795 payout(1). While the payout is down 1.3% from this time last year, it’s still a significant refund. And if strategically spent, can save you even more in the long run!

A recent survey from GOBankingRates.com(2) shows that many Americans plan to spend their tax refund wisely. Over 50% plan to pay off debt, invest or save their refund. Coming in at 16% in the survey? Americans plan to stash their tax refund into savings.

Build a Small Emergency Fund

If you don’t have an emergency fund, using your tax return (or part of it) to fund one is the first step in taking control of your money. According to Bankrate.com,(3) only 39% of American’s would be able to cover a $1,000 emergency with savings. This leaves the majority to find another way to cover the cost – typically using credit cards or other methods that in incur debt and interest.

Once you have an emergency fund to cover those potential unexpected emergencies, the next step towards controlling your finances is to pay down any existing debt. That’s exactly what over a quarter of those surveyed plan to do with their tax refund. With the national debt at an all-time high of $13.54 trillion,(4) it’s not a surprise that 27% of taxpayers want to use at least part of their tax refund to pay down debt.

What would this look like? We took the most common average American household debts and ran the numbers to see what would happen if you put your tax refund towards them. The results were staggering! Read on to see how much you can save with these simple steps.

Take on Debt With Your Tax Refund

1. Chip Away at Credit Card Debt
In the 4th quarter of 2018, credit card balances rose to $870 billion(4) – marking the first time credit card balances have retouched the 2008 nominal peak. According to Nerdwallet,(5) the average credit card debt per household is $15,561. If you’re only making the minimum monthly payment of 2% with an average annual interest rate of 15%, it will take you approximately 6.5 years to pay it off. That’s assuming you don’t charge any more on your credit card during that time.

Now, let’s say you take your tax refund of $2,795 and apply it to the balance of your credit card. This one small move means paying it off almost 2 years quicker and saving $3,890 in interest.

What if you take it a step further? What if you adjust your withholding so that Uncle Sam isn’t holding on to it (interest-free, I might add) for the next year? You could bring home an extra $233 a month ($2,795/12) and apply it to your credit card debt. In this scenario, you’d pay off 3 years faster and save over $8,170 in interest! Your initial tax refund of $2,795 almost triples its value!

2. Stamp Out Student Loans
Another option is to use your tax refund to pay off your student loans. Student loan debt is at an all-time high of 1.46 trillion dollars(4) with the total owed by an average US household totaling $47,671.(5) At an average interest rate of 5%(6) your monthly payment would come to $506 per month. That amounts to $23,836 in total interest over a 10 year repayment period. Yikes!

What if you decided to use your tax refund to lower the loan balance and make the additional $233 monthly payments? It would mean saving $9,733 in interest and shaving 4 years off the loan period! Not bad.

3. Crush Your Car Loan
Car loans are another debt to consider paying off, especially since their value can decrease rapidly. Experian’s latest research(7) shows that the average new car loan is $30,977 with a  7.04% interest rate. The average auto loan term for new vehicles is almost six years. Using your $2,795 tax refund along with increasing your monthly payments of $233, you can save $3,634 in interest and pay off your wheels in 4.5 years!

Invest In Your Retirement

Got your debts and savings covered? Consider kick-starting or adding to your retirement account. Retirement in the US is approaching a crisis. In the coming decades, millions of Americans will get too old to continue working but will not have the means to retire. While stats may differ slightly by source, the story is pretty much the same. A 2018 study by Northwestern Mutual(8) shows that 21% of Americans have absolutely no retirement savings while an additional 10% have less than $5,000! One in three Baby Boomers currently in or approaching retirement age have between $0 and $25,000 set aside.

With an initial investment of $2,795 and $233 monthly contributions, you could grow your retirement account by $377,820 over the next 30 years ($86,675 in contributions & $288,144 in growth*). Talk about peace of mind.

So, whether your tax refund is fairly substantial or just a drop in the bucket, putting it to work for you can improve your financial situation! You can even treat yourself – just don’t blow it at on a huge, unnecessary splurge.

The information contained herein is general in nature and based on authorities that are subject to change. Churchill Mortgage guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Churchill Mortgage assumes no obligation to inform the reader of any changes that could affect information contained herein. This publication does not, and is not intended to, provide legal, financial, tax or accounting advice, and readers should consult their advisors concerning the application of tax laws to their particular situations.
*assumes an average return of 8% per year
1. https://www.irs.gov/newsroom/filing-season-statistics-for-week-ending-april-12-2019
2. https://www.gobankingrates.com/taxes/refunds/what-americans-do-with-tax-refund/
3. https://www.bankrate.com/banking/savings/financial-security-0118/
4. https://www.newyorkfed.org/newsevents/news/research/2019/20190212
5. https://www.nerdwallet.com/blog/average-credit-card-debt-household/
6. https://www.nerdwallet.com/blog/loans/student-loans/student-loan-interest-rates/
7. https://www.experian.com/content/dam/marketing/na/automotive/quarterly-webinars/2018-q4-safm.pdf
8. https://news.northwesternmutual.com/2018-05-08-1-In-3-Americans-Have-Less-Than-5-000-In-Retirement-Savings

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