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Lisa and Beth recognize that paying down debt has to be a top priority. If they do not employ a strategy to pay off their credit card bills and auto loans, they simply will not be able to achieve their other financial goals.

Debt Pay Down Plan: We worked with Lisa and Beth on a debt management plan that involved paying down their credit cards beginning with the balance on the highest interest rate first. They have earmarked $1,400 per month for paying off credit card debt plus a small personal loan to Beth’s parents. This concerted effort has already enabled them to pay off a couple of credit card balances in full. However, even at this rate, it will take more than six years to pay off their credit card debt of more than $40,000.

Lisa and Beth also have auto loans totaling more than $95,000 between two motorcycles and two cars. In each case, the value of the auto is close to the amount of the loan. We discussed selling these autos as a way of reducing this high level of debt, but Beth and Lisa consider keeping these cars and motorcycles a top financial priority. So they have budgeted $2,850 a month to service these auto loans, some of which doesn’t mature for another six years. Again, we discussed paying off those loans with the highest interest rates first.

This debt payment regime is long and arduous. It eats up approximately $4,250 per month, more than 40 percent of their after-tax income. It prevents them from considering other goals such as purchasing a home or traveling abroad. It can also present a constant worry. Lisa and Beth acknowledge this burden and are committed to paying off their consumer debt.

Expense Control: Lisa and Beth have significantly reduced their discretionary expenses in order to expand their ability to pay down their debt more quickly. By combining households, they have found that not only have they consolidated some household bills, but also that they dine out less and spend less on general shopping. This discipline has allowed them to achieve a positive cash flow even with their heavy debt burden.

Debt Management Ratios

Knowing how much Lisa and Beth spend on discretionary and non-discretionary expenses is important. But financial planners also tend to analyze the percent of money spent on various expenditures and liabilities. For instance, consumer debt (credit cards, auto loans, etc.) should not exceed 20 percent of net income (gross income minus taxes). In Lisa and Beth’s case, at the time of this analysis, it is approximately 40 percent. In order to afford these high payments, Lisa and Beth live in a rental home that costs approximately 16 percent of their gross income. The general rule of thumb is that monthly payments on a home (including principal, interest, taxes and insurance) should be no more than 28 percent of their gross income. Lisa and Beth must pay significantly less than this in order to pay down their consumer debt. Until their credit card and auto loan payments are under control, they will not be able to afford to purchase a home.

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