Saturday, December 13, 2008

On debt

Sometime ago I met a guy that tried to sell me a debt reduction program. Basically, the deal was that I had to pay $3750 to get a computer program that would tell me how to allocate payments to serve any debt that I could have. Furthermore, he claimed this program was able to compress debt. He put himself as an example: he had 19 years to go in his mortgage, but he paid it in 6.

And you know why this works? Because the program has an algorithm. He even asked me if I knew what an algorithm was.

Now of course, since this works, I can recoup my $3750 by selling the program to a few other people that I know, and since I get $1000 every time I sell it... and so on... well, you get the idea. A typical multi-level marketing scheme.

He must have observed I wasn't too moved by his arguments, because then he suggested that I could buy the program used to do evaluations on people at $175, and still get the $1000 per customer I dupe into this.

So let's set the record straight, algorithm and everything.

The most important rule for debt reduction is simple. You can do whatever you want with the money you earn, but you are not allowed to increase your debt.

Let's say you want a camera today but you only have 40% of its price in available cash. Well, that's too bad: you get to save money month by month until you can buy it cash.

Or let's say that you want to buy a camera today, but you will have all the cash available in a few days. Fine, use the credit card. But when the statement comes, you are not allowed to let it go higher than before.

Now that things are not getting worse, we go to the second rule. This one is about scheduling payments. The debt dollars that cost you more in interest are those attached to higher interest rates. Therefore, you must pay those first. And yes, that means that if you owe $100 at 20% and $10k at 19%, you pay the $100 at 20% before you go after the chunk at 19%.

How do you pay the higher interest debt first? Simple. By allocating minimum payments to everything else, and then using as much as you can to go after the high interest debt.

For the sake of illustration, imagine you have $10k at 8%, $15k at 7%, and $20k at 9%. Assume you have $1000 to pay bills. Then, you make the minimum payments on the $10k and $15k, let's say those are $190. So you have $810 left, and that's what you pay on the $20k.

So now, rule 1 says you will not get worse. Rule 2 says you're paying in the most efficient manner. The third and last rule says that you must include every debt into this arrangement. In other words, your car and mortgage payments also count.

If you follow this strategy, then you will be out of debt in no time. And please, don't do stupid things like paying $3750 to have a program tell you how to allocate payments. Besides the fact that this would violate the first rule, you do not really need help to pay bills yourself. Also, you will avoid paying for the cruises these salespeople take.

Pfft... algorithm...

Finally, what do you do when you pay all your bills and have zero debt? Assume that your savings account needs money, and periodically drain any gross excess out of your checking account. You will be amazed at how quickly you can build up savings in this way. Then get yourself some goals and go after them.

PS: The fine folks at Debt Consolidation Connection left me the following comment.

Charge the $3750 to your credit cards. That would be a good start!

Not only this is spam: it is nonsense. Gee, you're so much in debt that you're looking for help, so how about you pile another $3750 on your credit card to start getting rid of your obligations? You have to be kidding --- or scamming people into giving you money for no good reason.

Oh, and by the way, multi level marketing schemes are a whisker away from being a pyramid / Ponzi scheme, which would make them illegal. And don't just take my word for it, see here.

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