Personal Finance Case Study: Young Couple Overwhelmed With Debt

Starting today on Trees Full of Money I’m featuring a series of personal finance case studies to help readers visualize the process my family and I used to pay off a large amount of consumer debt a few years back. If you’d like your specific personal finance situation to be featured in an upcoming article (your identities will remain anonymous) just send me an email.

Today’s personal finance case study focuses on a younger couple who are completely overwhelmed with debt and desperate to get their financial lives turned around before the birth of their first child.  Their goal is to reduce their consumer debt over the next few years and start saving for retirement and establish college funds for their children.

According to the couple, “no matter what they do, they just can’t seem to get ahead” and whenever they do have some extra cash they end up “blowing it” on “crap” they don’t need.

The Reality of Their Personal Finances:

As with any personal finance assessment, the first step is to make a detailed list of all outstanding debts/loans, utility bills and other monthly living expenses. In addition to monthly expenses, they’ll also need to add up their monthly “take home” pay (how much money they actually bring home each month).

For convenience, I’ve organized the specifics of our couple’s personal finance case study into the Excel Chart below. If you’d like to use this Excel file for your own situation, you can download it here:

The good news for our couple’s personal finances is that “technically”, they should have some money left over at the end of the month. However, its obvious with their level of debt that they have been spending way more than they earn each month.  This couple really needs to find out where all of their extra money is going.

By following my advice on creating a realistic family budget that your family can actually stick to, our couple was able to successfully “trim the fat” from their monthly expenses and actually have the $1325 left over at the end of the month.  This is good because we’re going to be using this as a “debt snowball” payment further on in our case study!  

After talking with them a little more, we learn they don’t have any money in their savings (emergency fund or otherwise). I also learned the wife hadn’t enrolled in her employer’s 401K program yet (the husband was self employed).

On the plus side, the couple has health insurance through the wife’s employer and they both have a decent amount of term life insurance (8 times their annual incomes) to protect each other’s incomes in the event something were to happen to one or the other (they pay only $35 per month for this).  They also have  wills in place which addressed their respective estates and care for their yet to be born child(ren).

Most of you who’ve been reading my personal finance blog for any length of time know that I am a big fan of personal finance guru Dave Ramsey and his approach to personal finance. While I don’t agree with everything he says, I believe his 7 Baby Steps to Finance Freedom are a decent foundation to base a financial plan on.

One Quick Adjustment:

Contrary to Dave Ramsey, one of the first things I would have this couple do is enroll in the wife’s company’s 401k program and contribute at least enough money to get her employer’s maximum match. For instance, if her company matches her 50 cents on the dollar up to 3% of her salary. She should enroll in her 401k program and contribute at least 3% of her pay in order to get the full company match. Otherwise she’s essentially missing out on “free” money.

Get an Emergency Fund in Place:

The biggest concern I have for this couple is they don’t have any emergency fund in place. This is especially troubling since the husband is self employed (and presumably has an unpredictable income) and the fact the couple is expecting their first child. While most personal finance experts recommend emergency funds to cover 3-6 months living expenses, this would be a lengthy goal for our couple, especially considering their level amount of monthly debt payments.

A more realistic option is for the couple to set about $2000 in an emergency fund to help protect them from the expense of any emergencies. As Dave Ramsey suggests,  the idea of a “baby emergency fund” is to “cushion” the couple’s ability to prevent acquiring any more debt than they already have.

Start Eliminating Debt:

The next step for this couple is to do what they can to eliminate or pay-off their debt. I see no need why this couple needs a loan for $19,000 to own a second car. My advice would be to sell the vehicle themselves and buy an inexpensive but reliable $4-5K car. Even if they are “upside down” on the vehicle (negative equity), there are still ways they can sell the car for less than they actually owe on it and still get a loan for another car.

I would also look at any additional “assets” the couple could sell to pay down or eliminate their debt. When my family and I started aggressively paying down our debt, one of the first things we did was sell my motorcycle. This freed up money that we could use to pay off some credit card bills we had.

The next thing I would do is plug the debts and loans the couple provided into my debt snowball program that calculated how quickly the debts would be paid off. For more information on how the debt snowball payoff process works, click here.

Here is what their debts will look like in the debt snowball spreadsheet, note that I have rearranged the debts starting with the lowest balance and working up to the largest balance:

Now comes the AMAZING part. Once we plug the couple’s numbers into the debt snowball calculator, we get some very encouraging results showing how quickly this couple can become debt free.  Review the original Excel Debt Snowball Analysis Worksheet here.

Applying the couples “left over” money ($1325) at the end of each month to debt, the couple will have knocked out their first two debts (Credit Card #2 and the Personal Loan) by the end of the second month (with a little money left over).

By the end of the 6th month, the couple will have paid off Credit Card #1 as well.

Keep this up for 5 more months (now 11 months into our scenario) and the couple will have paid off Auto Loan #2.

8 months later (now 19 months into our scenario) the couple will have paid off the student loan debt as well!

Finally after an additional 7 months (now just over two years into our plan), the couple will have paid off the Car Loan #1 leaving only the mortgage to be paid.

With a plan in place, and the motivation of seeing that pay off their debt is actually possible, our couple can stay focused and possibly cut additional expenses out of their lives to speed up the debt free process even more!

Remember, even with their “large amount of debt” this couple can pay off their debt in a reasonable amount of time without getting rid of any of their cars or changing other parts of their lifestyle.  Imagine if they went even futher and cut back their grocery bill and reduced their cable, cell phone and internet plans!  These steps would free up even more money that could be applied to paying down debt.

Building an Fully Funded Emergency Fund:

Now that our couple is debt free (excluding the mortgage) they’ll quickly be able to save 3-6 months of expenses in their emergency fund (especially since their monthly living expenses are substantially lower now that they don’t have those lingering debt payments).

Accelerate Retirement Savings:

After fully funding their emergency fund, our couple needs to start increasing their retirement savings. The wife should consider “maxing out” her employer’s 401k and start either a Roth or Traditional IRA for her husband.  By now our couple is in their early thirties allowing at least 25-30 years to save for retirement.

Start College Savings Accounts:

Our couple is passionate about helping their children pay for college and now that they have some extra money available (since they don’t have a mountain of bills) they can easily afford to start funding an Education Savings Account (ESA) or 529 College Plan for their young children (we’ll assume they have 2 by this point).

Pay off the Mortgage:

The next step in our scenario is to pay off the mortgage. The concept of paying off a mortgage early is inconceivable by most people, yet it is surprisingly achievable using the same debt snowball technique we used to wipe out the other debts.

Believe it or not, even if our couple never gets a pay raise or sells any of their current vehicles or other assets, they could continue making the debt snowball payments and be completely debt free in an additional 44 months. In other words, this couple (now family) that was completely overwhelmed with debt would be able to completely pay off all of their debt including their mortgage, have a fully funded emergency fund, and have respectable retirement and college savings accounts in 70 months (less than 6 years)!

Sounds like a pretty good financial plan to me!  What would you differntly?  Please leave your comments in the comment box below!

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