A Step-by-Step Guide to Reducing Debt on an Irregular Income

Recently, Ramit at iwillteachyoutoberich had a question for his readers asking how to budget on an irregular income. I modified the problem a little bit to specifically address debt reduction on an irregular income. Here is the step-by-step guide. Let me know what you guys think.

  1. Make a list of all necessary expenses such as rent, groceries, utilities, car payment etc. (We will leave out the non-basic things like entertainment, hobbies, pub-hopping etc. for now and come back to it later.)

  2. Add a number to each category using the following guidelines
    1. For fixed categories such as rent, car payments etc use the actual amount.

    2. For variable categories such as groceries, gas etc find out the minimum amount you require to sustain yourself and use this figure.

    3. For variable categories such as electricity, water and gas bills, use the maximum amount you require to pay off the bill in full.

    Now add it all up. Let’s call this total, $A.

  3. Make a list of all your loans. List one as the primary (Financially, it makes better sense to pick the loan with the highest interest rate. Psychologically, Dave Ramsey’s snowball method might be better, in which case you need to pick the one with the lowest balance).

  4. Find out the minimum due for each loan and list it. Add it all up. Let’s call this total, $B.

  5. Determine what your lowest possible monthly income is. Let’s call this $C.

  6. Is ($A + $B) less than $C? If not, go back to step 2 and tweak the amounts. (Eg., Do you need to move to a lower priced apartment? Do you need to take the bus instead of car? etc). Repeat, until ($A + $B) is less than $C. Note: This step is not complete until ($A + $B) < $C.

  7. Open four accounts. Call them, "Basic Necessities", "Debt", "Savings" and "Fun Stuff" (You can use 4 separate envelopes instead of four separate accounts too).

  8. Every time you make some money,
    1. First put it in "Basic Necessities" account until it totals $A.

    2. Next start putting the money in the "Debt" account until it totals $B.

    3. Anything beyond, put 50% in the “Debt” account, 25% in the “Savings” account and 25% in the “Fun Stuff” account. (See “Assumptions” below)

  9. Every time you have to spend money,
    1. Pay all household bills from the "Basic Necessities" account.

    2. Pay minimum balance on all the loans other than the primary loan from the “Debt” account. Pay the remaining amount towards the primary loan. (If you have calculated correctly this should be at least equal to the minimum balance. Always, double check before sending the check out!)

    3. All the fun stuff (everything other than the basic necessities) should be funded by the "fun-stuff" account. The money that you carry with you when you go out comes from this account. This is where the money for all your entertainment, hobbies, habits and vices should come from. NEVER dip into the "savings" account.

    4. Invest the "savings" account wisely. At the very least, this account should be an online high yield savings account (current average APR ~5%). This is where the money for the down payment of your home, retirement, emergencies etc. comes from.

  10. At the end of a year, it is very unlikely that there will be any money left over in the “Basic Necessities” or “Debt” account. But if you are frugal, you might have some money left over in the “fun-stuff” account. This is your reward! Spend it as you see fit. If you want to splurge, go ahead and splurge! If you want more wiggle room in your basic necessities, transfer it partially/fully to the “Basic Necessities” account. If you want a bigger buffer for emergencies, transfer it to your “Savings” account. If you want to get rid of debt faster, send an extra check to one of your loans.

Thats it! Stick to these steps and sooner rather than later, your debt will be all paid off! By the way, this guide makes some assumptions –
  1. You can determine what the minimum income per month is.

  2. You will only use cash until your debt is paid off. You could use credit card if you want to, as long as you make sure that the monthly payments are split according to what categories they belong and are funded by the relevant account. And of course, it goes without saying that if you use a credit card, you should always pay it off in full each month!

  3. The percentages in step 8c are just suggested values assuming that you have high interest debt. If your loans are low interest student loans, or if your priorities are different, modify these percentages accordingly.

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