The good news is that money problems can often be overcome.  Even the worst financial conditions can be turned-around or at least improved.  There are simple steps to mitigate money problems and turn the corner towards prosperity.

Step 1 – Face the Problem

Photo by What Meg Said

I read a sad story in Yahoo Finance about a woman with $555,000 in student loan debt.  Her loan balance was around $250,000 when she graduated from medical school in 2003.  But, she deferred her loans and then defaulted.  So, the interest and penalties more than doubled the outstanding loan balance.

This illustrates an important aspect of personal finance and life in general.  Ignoring a problem almost always makes it worse.  You can’t make money problems go away by ignoring them.  You have to face them head on.  Even if this is unpleasant for you.

Step 2 - Identify the Cause

Every situation is different.  But, here are four main causes of money problems:

• Too little income to support yourself
• Too high of expenses for your income
• Lack of spending or budgeting discipline
• Debt interest undermines your finances

If you don’t know which of these items is the cause of your money problems, I would start by looking at your budgeting and spending discipline.  I don’t live on a strict budget myself, but I do know where my money goes.  And, I have dealt with all of the above circumstances.  So, I understand exactly how frustrating each can be.

Income - Living on a poverty level income is something I don’t recommend for anyone.  In fact, I consider it to be the single biggest mistake I have made.  Income can be increased, but it’s not easy and it can’t be done quickly.  First, try to improve your wages at your current job.  If that doesn’t work, look for a better paying job.  The best long-term solution is to increase the amount of money you earn per hour.  If that can’t be done, pick up a second job or start a side-hustle.  For the short-term, this is often the easiest solution.

Check Out: Practical Advice for the Career Challenged

Expenses - Reducing your expenses may be the easiest way to improve your finances in the short-term.  And, you have a lot of control over discretionary expenses.  The big problems come from big fixed costs, such as mortgages and car payments.  These costs can’t be easily reduced and they can haunt your finances for years.  Avoiding the new car treadmill and too much house pitfall are two of the best things you can do for your finances.

Check Out: Living Large on what you Earn

Discipline - If you can’t say off the top of your head where 90% of your money goes, you probably lack spending and budgeting discipline.  This is crucial, because you may be squandering the money you need to be saving.  Otherwise, you will never get ahead.  Whatever budgeting method you use, you need to get a handle on your spending and plug those money leaks.

Check Out: Why I Never Budget

Debt - The problem with debt is the interest, which depletes your finances.  And, the worse you are in debt, the more vicious the fees and interest become.  It can seem nearly impossible to climb out of debt, because it keeps piling on faster than you can pay it off.  Take heart and check out the plan below.  It is a sure-fire way to help pay off debt.

Check Out: The 10-20-70 Plan for Paying Off Debt

Step 3 – Formulate a Plan

Most people don’t want to look at the reasons why they are having financial problems.  It’s something they would rather avoid.  But, having a plan is very empowering.  It gives you the courage to face these problems and the enthusiasm to overcome them.  Without a plan, you will continue to fail.

When formulating your plan, make sure you put everything on the table.  Look objectively at the reasons you are in trouble and the costs associated with each item.  Don’t give any of your indulgences a free-pass.  I know someone who may lose their house to foreclosure, but is unwilling to get rid of one car payment.  And, they have two new cars.  In order to make changes to your finances, you will have to make changes to your lifestyle. 

Check out: Four-Step Debt Evaluation Plan

Step 4 – Implement your Plan

Planning is worthless without action.  And, action is worthless without commitment.  If you haven’t formulated a solid plan and aren’t committed to its success, you won’t be successful.  You will either fail to make the decisions that are necessary or sabotage your efforts and blame circumstances.

You also need to implement your plan in a way that is sustainable until completion.  If your plan is too strict and doesn’t allow for any fun or entertainment, you may give up.  There will be setbacks during your journey and you should plan for this now.  Prepare yourself for small disappointments and keep your momentum going for the long-haul. 

The Bottom Line

The bottom line is that small changes can add up to big results over the course of a lifetime.  The habits you chose to cultivate now may make the difference in the future you create for yourself.  Think of pleasant times ahead and then go out and make it happen.  Here’s to a life free of stress and money worries.

“Empty pockets never held anyone back.  Only empty heads and empty hearts can do that.”

Norman Vincent Peale – Preacher, Author & Motivator

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So, without further delay, here is the plan:

The 10-20-70 Plan

1. Save 10% of your Net Pay
2. Pay 20% of your Net to Debt
3. Spend 70% to Live Joyously

Why the 10-20-70 Plan Works

There are a number of reasons why this simple plan works so well.  The most important reasons are that it is balanced and sustainable.  There is no shortcut or magic to debt reduction.  Any permanent solution requires lifestyle changes that keep you spending less than you earn.  Having a sound repayment plan is a great start.  But, then you need to remain debt-free forever.  The best way to accomplish this is to have enough spending money to live comfortably.

It is well known and documented that people who discharge or refinance their debt have a greater than 80% chance of being back in debt within a short period of time.  The banks call this “reloading” and they have it factored into their risk models.  So, if you think you can shed or shuffle your debt, you will only be treating the symptom and not the cause of your problem.  Instead, you need to break the spending habits that caused your debt in the first place.

Where the Plan Came From

This plan came from my favorite little book, The Richest Man in Babylon.  In the book, a number of characters were in desperate trouble with debt and they were helped tremendously by this plan.  My personal experience is that it definitely works, although I’m much better at saving than debt reduction.

I use a modified version of this plan that is 20-20-60.  I’m very fortunate to be making good money right now and I am taking advantage of the low market prices to invest more.  The living joyously part is my own addition.  After a little practice, it’s quite easy for most people to live on 70% of their income.  And, the best part of this plan is not having to squeeze pennies to reduce debt.  You can and should have fun while you are working yourself out of debt.

Saving while you’re in Debt

The 10% savings is the most controversial part of this plan.  Many people believe the debt should take precedence over savings because the debt usually has a higher interest rate.  Although this may seem to make sense mathematically, it never makes sense to pay everyone but yourself.  Being broke is always a bad financial plan.  If you aren’t saving, you aren’t accumulating wealth.

That’s why Saving 10% is the number one item on the list.  Pay Yourself First, before anyone else gets their money.  Some people call it an emergency fund.  I call it my wealth fund.  Either way, it always makes sense to have some money put away.  Savings and debt reduction are separate goals that must both be accomplished.  So, don’t neglect one for the other.

Special Circumstances

Everyone’s financial circumstances are different.  If you have little or no income, this plan isn’t going to help you.  Your plan should be to generate more income.  If you have extreme debt that cannot be reduced with 20% of your income, you may need to seek help from professionals.  If you can’t live on 70% of your income, you may need to make some lifestyle changes.  For example, you may need to sell a car or move to a cheaper housing.

The Bottom Line

The bottom line is that debt is very hard to pay off.  But, it’s a pretty simple matter to take control of your debt.  You just need a plan and a commitment to eliminating debt from your life.  Otherwise, you may remain in debt forever.

“Debt is the slavery of the free.”

Publilius Syrus – Roman Author

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Credit is the Root of All Evil
Cardholders Bill of Rights Act

Pending Legislation

President Obama, Congress and the Treasury Department are slowly starting to shut down the deceptive practices of credit card companies.  Each has a slightly different plan in mind, but all three provide comprehensive protections.

Credit Cardholder’s Bill of Rights Act

I have been following this bill (H.R. 5244) for well over a year now.  It’s sad that it’s taken so long for this bill to come to the floor.  The banking lobby is very powerful and has done everything in their power to kill this bill.  Amazingly, it has finally passed committee and may start debate on the floor as soon as today.  The Senate is considering a similar bill, which makes it likely this will pass in some form.

The main components of this bill are:

• Protects cardholders against arbitrary interest rate increases
• Prevents cardholders who pay on time from being unfairly penalized
• Protects cardholders from due date gimmicks
• Shields cardholders from misleading terms
• Empowers cardholders to set limits on their credit
• Requires card companies to fairly credit and allocate payments 
• Prohibits card companies from imposing excessive fees on cardholders
• Prevents companies from giving credit cards to people who can’t afford them
• Requires Congress to provide better oversight of the credit card industry

President Obama’s Plan

President Obama made campaign promises of credit card protections and now he is following through.  Last week, he summoned representatives of the major credit card issuers to Washington.  He discussed “strong and reliable protections for consumers” and provided some core principles for reform.

Reforms outlined in President Obama’s plan include:

• Banning unfair interest rate increases
• Forbiding abusive fees and penalties
• Ending late-fee traps
• Forms and statements must be printed in plain language
• No more fine print or confusing terms and conditions
• Contract terms must be accessible for comparison shopping
• Require every issuer to have a plain vanilla, simple terms credit card
• The Government will have more effective oversight and enforcement

The Treasury Department Plan

The Office of Thrift Supervision enacted the first legislation for credit card reforms and it was similar to the Bill of Rights Act.  Unfortunately, the OTS gave banks until July of 2010 to comply.  Banks responded promptly by raising fees and interest rates.  Either they felt they could circumvent the reforms or they considered it a license to steal for another 18 months.

In the past, banks may have gotten away with such an arrogant response.  But, in the current economic climate, they may have caused a backlash that brought about the reforms by Congress and the President.  Either way, I applaud the reforms taking place and I’m hopeful consumers won’t be exploited for another year.

Doing what’s Right

Many people believe irresponsible consumers are solely to blame for their own credit card problems.  I’m not one of them.  Although consumers have been irresponsible with credit, that’s no excuse for banks to cheat them.  And, it’s no excuse for the Government to allow them to be preyed upon.  In my opinion, this is an example of kicking people while they’re down.  It’s disgraceful and it never should have happened. 

The best way to keep consumers responsible is to not extend credit they can’t afford to pay back.

Besides, these deceptive practices also harm consumers who are responsible with their credit.  Delayed billing, shifting due dates and 10:00 AM cut-offs create late fees even for those who pay their bills on time.  One of my credit card companies was sued for delayed processing of their mail just to create more late fees.  This type of fraud generates millions of dollars for banks and goes unpunished.

The Bottom Line

Credit card companies have been allowed to use deceptive practices on consumers for far too long.  Reform is way overdue and definitely welcome.  One thing is crystal clear to me.  Irresponsible banks are the primary cause of the financial crisis.

Consumers have also been irresponsible.  Their excessive borrowing was encouraged by banks to generate higher profits.  Now that it has backfired on everyone, consumers are paying a heavy price, while banks are receiving a bailout.

It’s time for banks to become accountable for their actions.

Sign on a Bank:

“We can loan you enough money to get you completely out of debt.”

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Here are the Grim Statistics

• The delinquency rate on residential properties was 6.35%.
• The percentage of loans in the foreclosure process was 2.47%.
• Loans with foreclosure actions started this quarter were 0.99%.
• The number of homes in foreclosure is around 1.1 Million

The Vicious Cycle of Foreclosure

Unfortunately, the foreclosures contribute to a breakdown in property values, as the market is flooded with vacant properties that must be sold.  This drop in property values then causes more foreclosures as delinquent homeowners realize that they owe significantly more than their houses are worth.  The temptation to just walk away increases as it becomes obvious that it is impossible to sell a house at market value in this environment.  Soon, desperate For Sale signs plague the neighborhood and continue the cycle.

The Haves and Have-Nots

Surprisingly, even in this disastrous environment, most homeowners are just doing fine.  Those with good jobs and good loans aren’t in much danger of defaulting.  Unfortunately, for people in the mortgage, real estate, housing or construction industries, it’s going to be a bumpy ride.  And, for people with adjustable-rate mortgages, the situation is getting desperate.  Subprime ARMs represent only 6% of outstanding loans, but 39% of the foreclosures.

The Bottom Line

The bottom line is that opportunity is knocking for those who are thinking of buying a house or a rental property.  These conditions are ideal for buyers and they won’t last forever.  Even if you think you can’t buy a house right now, you may be able to buy a foreclosure property.  Just don’t be like the previous owners and get in over your head.  And, for god’s sakes, get a fixed loan if at all possible.  Inflation is on the rise and interest rates are definitely going to have to be raised.  They may need to be raised a couple of percent.

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Four-Step Debt Evaluation Plan

1. Make a list of every debt you owe.

2. Next to each debt, put a minimum payment amount.

3. Total up all of the minimum payments and write it down.

4. Decide how much you can pay each month and write it down.

If You Can’t Afford the Minimum Payments

You are in real financial trouble and you need to take immediate action.  The longer you avoid this situation, the worse it is going to get.  You need to decide right now if you are willing to make the kind of lifestyle changes that will allow you to crawl out of debt.  My recommendations would include downgrading your lifestyle and getting a second job.  Cutting back on lattes and bagels isn’t going to be enough.  You need to take more drastic action, like a cheaper car and cheaper rent.  You should probably avoid eating any place where you need to leave a tip and put off buying new clothes.

If you aren’t willing to make these types of changes, you should admit this to yourself and consider the consequences of being insolvent.  Face the facts, straight up and deal with it.  There is no fantasy world when it comes to bankruptcy.  It’s no longer easy to discharge debt.  And, you will pay for your indiscretions in many ways in the future.  I recommend bankruptcy only as a last resort.  I think this may be a good time to talk to professionals and I don’t mean those debt services on TV.

If You Can Barely Pay the Minimums

This may not be as bad as it seems.  First and foremost, stop accumulating debt.  Then, consider some of the lifestyle changes listed above.  If you can increase the amount you can afford to pay by only 30-50%, you have a great shot at getting out of debt in a reasonable amount of time.  Start by paying everything on time, so you can avoid late fees.  If any debt is over-the-limit, pay this first to avoid the penalty.  Avoiding these fees and penalties is a big key to dropping the balances.

If You Make Good Money but Can’t Get Out of Debt

There is no income level at which debt stops being a problem.  Often, debt grows even faster with increases in income.  Some millionaires have declared bankruptcy a number of times.  There’s no shame in being in debt.  But, it’s a shame if you choose to remain in debt, when you could be getting ahead and providing for a more secure future.

The problem of debt is three-fold.  First, you pay a lot of money to service the debt that you could use for other purposes.  Second, you greatly reduce your financial security, by increasing your required monthly expenses.  Third, you reduce your ability to save and plan for your future.  It’s a fiscally inefficient and insecure way to live.  And, it enriches the banks at your expense.

The Bottom Line

The bottom line is that crawling out of debt is hard.  I have personally struggled with debt and it doesn’t get any easier as your income goes up.  It takes a dedicated, committed effort, sometimes over a long period of time.  And, backsliding is inevitable, so be prepared for this.  Your car will break or you will face unexpected expenses at the worst possible time.

Keep paying and don’t lose hope.  Try to visualize how your new lifestyle will be, with a debt-free existence.  Calculate the future date, when you will be rid of your debts and pulling ahead financially.  Keep the faith and you will be rewarded.

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Here is a link to the announcement.

Here is my favorite quote from her announcement:

“Regrettably, regulators and prior Congresses have dropped the ball on protecting consumers in recent years.” 

That’s a pretty big understatement.  A more accurate statement would be that Congress has left their constituents at the mercy of credit card issuers and they have taken full advantage.  Nonetheless, it’s great to see someone finally putting a stop to these predatory practices.  Hats off to Carolyn Maloney and all of those in Congress supporting this bill.

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