Money and You: Course Notes

The first method for paying off debt is the better one long-term. The philosophy is simple: pay the most expensive debt first. With the highest-rate method, you focus on paying your debt with the highest interest rate first. Now, always make sure you’re making at least the minimum payments on all your debt. However, you will focus any money you can into paying off your debt with the highest interest rate.

The logic behind this method is that debt with the highest interest will accumulate more money that you’ll need to pay back over time. Debt with lower interest will accumulate slower and can be left on the back burner for a bit. Once your highest-rate loan is repaid, move to the next highest.

Suppose you have the following debt:

Each month, you would make the minimum payments on all four loans. However, you would put extra money toward your credit card debt. Having this extra money to pay toward your credit cards requires you to adjust your spending habits (or make even larger life changes). You would continue paying only the minimum amount on the other three loans while paying the credit cards as much as possible until the full $8,000 has been paid. You would then move onto your student loans.

In the long-run, this method will save you the most money because you are preventing more interest from accumulating. However, if your high-interest loans are also large loans, you may not have the satisfaction of completely eliminating a source of debt quickly.

The snowball method is a method that is great for seeing progress more quickly. However, seeing progress more quickly actually comes at the expense of paying more in interest long-term. Under the snowball method, you pay your debt with the smallest amounts first. The philosophy behind the snowball method is to get a source of debt eliminated entirely as quickly as possible. This not only gives you a great deal of satisfaction early, it also eases the emotional burden more quickly. Again, the downside is that your higher-interest loans will accumulate more interest, and you’ll likely need to pay more in the long-run.

Consider the same setup as in the highest-rate method.

Under the snowball method, you would make the minimum payments on all your debt, but you would put extra money toward your car loan because it has the smallest balance. You would continue this each month until the car loan was paid off. You would then move onto your credit cards.

If you are wondering why anyone would use the snowball method if it costs more in the long-run; the answer is psychology. Long-term goals are hard to maintain without seeing your progress. Imagine trying to lose weight without access to a scale or driving a long distance with no GPS to say how long is left. The snowball method can help you stay on track by getting you to a real milestone (paying off one source of debt fully) more quickly.

Consider the following scenario: Ishaq had always managed his finances prudently. He’s never missed a bill payment. He tries to be frugal. However, his job doesn’t offer great insurance and has a $10,000 deductible. While biking to work one day, he hit a patch of ice and crashed heavily. After his hospital visit, he was stuck with a $10,000 bill. He set up monthly payments with the hospital, but the payments are nearly $500 a month. He is having trouble keeping them up on top of his other debt. His debt is as follows:

Taking into account what method might be best for Ishaq’s personality, make a detailed plan to help him start to pay off his debt.

When a person or business is unable to repay their debts, they may work with the courts to help them come up with a plan to repay the debt. This process is called filing for bankruptcy. Generally, when you file bankruptcy, would agree to a short-term method of repayment, and after that period, your remaining debt is forgiven.

When you file for Chapter 7 bankruptcy, you will agree to having your assets “liquidized,’’ meaning that your stuff is sold for money. The court will look at your income, who and what you owe, and all the stuff you own (assets). They will appoint a trustee to facilitate the sale of your “non-essential’’ assets, the proceeds of which go to pay off your debts.

Many things can be identified as assets to be sold. Each state has a minimum amount something must be worth to be considered an asset to be sold. (No state will make you sell a $5 oven mitt.) Secondary cars, jewelry, investments, collectibles, and other expensive items will certainly be sold. Items necessary for survival (basic appliances, primary transportation, basic furniture, etc.) will not be sold. (Sometimes primary vehicles can be sold if they are particularly-expensive cars.) Housing is tricky. Certainly secondary homes will be liquidated. If you do not owe money on your primary home, it won’t be liquidized. If you do owe money and have not fallen behind on mortgage payments and do not have much equity, your house may not be liquidized. However, if you are behind on your payments, the house will likely be given to your mortgage bank. Or if you have a great deal of equity in the house, you may be forced to sell it.

Once the liquidation process is over, your debts will be forgiven. Keep in mind that some debts cannot be forgiven. Student loans, tax debt, and child support payments cannot be forgiven.

If you find yourself in a position to need to declare bankruptcy, Chapter 7 is a good option if you do not have many assets or if your income is low. It essentially is a “clean slate.’’ There are income limits for filing Chapter 7. Not having many assets means not having much that needs to be sold. A lower income will convince the court that a smaller amount of items needs to be sold.

When you file for Chapter 13 bankruptcy, the court will look at your income, expenses, and debt. The court will come up with a payment plan for you to follow for 3 to 5 years. This payment plan is generally less than what you would be paying on your debt. After this 3-to-5-year period, your remaining debt will be forgiven.

Chapter 13 is for people with regular incomes. Unlike Chapter 7, you can keep your assets and property. However, there are limits to how much debt you can have for filing Chapter 13. If you have too much debt, you will not be able to file.

Again, keep in mind that filing Chapter 13 will not eliminate student loans, tax debt, or child support payments.

The Good and Bad of Bankruptcy

Bankruptcy is a means of last resort to get out from burdening debt. If you have lower income and few non-essential assets, filing Chapter 7 can help you get a clean start in a short amount of time (usually about 6 months). If you have a regular income and some property, filing Chapter 13 can help you work through some of your debt in 3-5 years while keeping your belongings.

Keep in mind that declaring bankruptcy is seen as the ultimate sign of being unable to pay back on your loans. This means that it will greatly impact your credit rating. People who declare bankruptcy often find it impossible to get a loan for several years after declaring. Many people lose their homes during their debt crisis. While declaring bankruptcy may remove debt to allow you to pay for housing, you may find yourself unable to find a landlord willing to rent to you. Chapter 7 bankruptcy stays on your credit report for 10 years. Chapter 13 stays on your report for 7 years.

Bankruptcy should never be “Plan A’’ to get out from a loan. Bankruptcy is a situation in which it is necessary for a court to decide how much you can actually pay back. You then have a very large mark on your credit that will hinder your financial goals for a long time. Bankruptcy is a means of last resort. Yes, businesses have used money laundering techniques to get out of big bills through bankruptcy. If you’re savvy and unscrupulous enough to do that, you probably don’t need this course.

Bankruptcy is a means of last resort to get out from burdening debt. If you have lower income and few non-essential assets, filing Chapter 7 can help you get a clean start in a short amount of time (usually about 6 months). If you have a regular income and some property, filing Chapter 13 can help you work through some of your debt in 3-5 years while keeping your belongings.

Keep in mind that declaring bankruptcy is seen as the ultimate sign of being unable to pay back on your loans. This means that it will greatly impact your credit rating. People who declare bankruptcy often find it impossible to get a loan for several years after declaring. Many people lose their homes during their debt crisis. While declaring bankruptcy may remove debt to allow you to pay for housing, you may find yourself unable to find a landlord willing to rent to you. Chapter 7 bankruptcy stays on your credit report for 10 years. Chapter 13 stays on your report for 7 years.

Bankruptcy should never be “Plan A’’ to get out from a loan. Bankruptcy is a situation in which it is necessary for a court to decide how much you can actually pay back. You then have a very large mark on your credit that will hinder your financial goals for a long time. Bankruptcy is a means of last resort. Yes, businesses have used money laundering techniques to get out of big bills through bankruptcy. If you’re savvy and unscrupulous enough to do that, you probably don’t need this course.