You did all the right things. You had a budget and paid all your bills. Then the bank increased the payment required on your credit card balance. Pay-as-you-go won’t work anymore. Now what? You still have to eat.
This is happening to to more and more people these days. Good people who know how much income is coming in and allocate it in such a way that all their bills get paid, are getting slammed. It might be an increase in the mortgage payment due to a rate increase or a change in the terms on a credit card. Or perhaps an unexpected expense sends things into a tizzy. But something happens so that the numbers just don’t add up anymore.
If you are a member of the pay-as-you-go club facing an aparently impossible financial situation, perhaps I can offer a different way of looking at things that just might help you find a way out – without destroying your credit rating.
In a nutshell, you currently are probably trying to manage spending and cash flow as if they were the same thing. But by managing each as a separate thing, you may be able to actually use credit in order to reduce your total debt and still maintain a good credit rating. Here’s how it works.
Let’s say that John and Mary deposit $3000 per month in their checking account from their paychecks. $1200 is paid on their rent. $300 goes for the car payment. More goes out to cover insurance, utilities, cable access and other items that are more-or-less the same every month. And a certain amount is put aside (in an envelope or savings account) to cover the erratic expenses like fall wardrobe for school-age kids, gifts, new apliances when they wear out or repairs when needed.
They also have a $4000 balance on a credit card thay they are trying to pay off. They vowed to never use it again. The bank has been charging 15% interest (about $50 per month) and billing them for 3% of the total balance each month resulting in a current payment required of of $120. All of these items have been trimmed as much as possible already
When all is said and done, they have about $300 left over which they use to buy about $75 of groceries per week.
OK. These numbers might look silly compared to your personal situation. But, bear with me. We only need to look at a few of these items for me to make my point.
The crisis comes when the credit card company changes its terms and increases the interest rate to 20% ($67 per month of interest) and now requires a payment of 5% of the balance each month ($200). That is a payment increase of $80 per month. Since everything else has already been cut to the bone, That means cutting down to $55 per week for groceries. It can’t be done. Someone is going to go hungry – or will they?
You see an increase in necessary “spending” of $80 per month. I see an increase of spending of $17 per month and an increased cash flow requirement of $80 per month. Let me tweek some of those original numbers a bit and I think you will see what I mean.
Instead of saying the original budget provided for a “payment” of $120 per month on the credit card, I would say they actually were budgeting $50 to pay interest – a fee paid for the priviledge of using someone else’s money for a while. The other $70 is not actually spending. It is simply moving cash around – from the checking account back to the bank from which it was borrowed. Let’s call this the amount budgeted to reduce total debt.
As long as at least a little more than $50 is paid to the credit card company, the total debt will go down and the financial condition will improve (as the intrest costs come down.)
The solution: The new budget must increase the amount set aside to cover interest costs by $17 to $67. To compensate, we can reduce the amount set aside for “debt reduction” by $17 to $53. The amount reserved for groceries stays the same. Easy, huh?
“But wait”, you say. “I am now only budgeting $120 ($67 + $53). But, I need to pay the credit card company $200. So where do I get that missing $80?”
That’s the tricky part… You charge it. And it won’t get you any farther in debt. Here’s why.
Follow the money for a month watching only the money involved with groceries and the credit card.
Before: We start with $520 in the checking account. By the end of the month $400 came out of the checking account and went to the grocer and $120 went to the charge company. The balance in the checking account is now zero. The balance in the charge account went down by $70 (50 – 120). And everybody is happy.
After: The grocer needs to receive $400 per month. The credit card company wants to get a payment of $200. I pay the first week’s groceries with the credit card, the rest with checks. The grocer is happy. At the end of the month there is now $220 in the checking account. I send it all to the credit company. The minimum payment was made. The credit company is happy. The balance in the credit account went up by $100 due to the charge and $83 due to interest. But we were able to pay $220. So the balance actually went down by $53 (100 + 67 – 220), exactly the amount budgeted for debt reduction.
I know it sounds crazy. But, it will work… as long as you follow a few simple rules.
1. Budget how much you spend and stay within your limits. Spending is spending – regardless of the source of funds.
2. Budget enough to cover finance charges – not payments.
3. Budget at least a few dollars for debt reduction.
4. If you need more cash to make debt payments, use credit instead of cash for as many things as you need to preserve the cash balance in the checking account. Spending is spending – regardless of the source of funds. Cash flow management is deciding which source of funds to use.
5. Always pay at least the minimum payment required to the credit company plus repaying any surplus charges. Compute it as the amount required to pay down the balance to a level lower than the previous month’s balance by the amount budgeted for debt reduction.
Always remember, the more you pay down your debt, the lower your interest costs will be. And as you are able to reduce the amount budgeted for finance charges, you can increase the amount budgeted for further debt reduction or anything else you choose.
So, when things look hopeless, read this again and perhaps you will find that there is a glimmer of hope after all.