Debt Snowball Method

Over a year ago, Jammie and Cornell Brooks of Peoria, Illinois, were $54,200 in debt with two young children. Of that amount, $37,000 was in car loans, $6,000 was in student loans, $5,600 was in credit card debt, and the remaining debt was in department store cards.

When Jammie, 33, decided to return to school in fall 2004 to become a dental hygienist, Cornell, 34, who made $13 an hour as a team leader in the appliances department at Lowe’s, accepted the responsibility of paying all the bills. It was grueling and he often turned to credit cards to supplement Jammie’s missing $18,000 yearly salary as a dental assistant.

Once Jammie completed her program in 2006, she was able to increase her annual income to $39,000. Two years later, Cornell became a firefighter, boosting his earnings to $60,000 a year. But even with a combined income topping $99,000 a year they were still living paycheck to paycheck.

“Whenever we got paid we didn’t have any money left over. We were tired of living like that,” says Jammie.

It wasn’t until Cornell’s colleague encouraged him to read The Money Makeover by financial expert Dave Ramsey last January that Cornell and Jammie  began to understand how to break free from debt. “I read success story after success story and thought, ‘Why can’t that be us?’” recalls Cornell. “I was so excited I couldn’t wait to get home and tell my wife.”

Determined to win their battle over debt, the couple sat down and outlined a budget. “We sacrificed, we shopped less, and we started to eat differently,” says Jammie. But changing their eating habits was only a start.

“We sat down with a pen and paper and put all of our expenses on the left column of the paper and then put our income in the right column and then we cut the fat,” explains Cornell. They eliminated  unnecessary expenses like cable,  landline phone, and water home delivery services. Family trips were capped at $300 and  they lowered their car liability coverage. Both agreed to forgo impulse purchases.

Through cutting expenses and gaining additional money from Cornell’s side job fixing brakes, the couple produced a monthly disposable income of about $3,000. Moreover, they soon realized they could manage their household on Jammie’s $39,000 salary. Her paychecks were deposited into the family’s joint account to pay for monthly expenses and day-to-day needs. Meanwhile, Cornell’s bimonthly paycheck of $1,200 was applied to their debt.

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By February 2011, they started eliminating credit cards with the smallest balance while continuing to pay the minimum on other debts. Once paid, they applied that money to the next debt and continued the process until all outstanding bills had been paid off–”the snowball plan” advised by Ramsey.  The couple says  the “quick wins” gave them a sense of accomplishment and the motivation to press forward.

The Brookses first tackled consumer debt by taking $5,000 in savings to pay off their four store card balances. In March, they paid  almost half of their Discover Card balance; their tax refunds wiped out the remaining balance in April.

They applied the leftover from their refund to Jammie’s student loan. After making two payments in May, the couple was able to rid themselves of that debt.

Next were their car loans. Cornell used a home equity line of credit

to pay off the first car in May 2011. The HELOC allowed them to lower monthly payments and interest rates from $378 per month at 7.24% to $163 per month at 4%. After five payments they were able to fully repay the line of credit. They started paying the debt on their second car using the same method in January 2012 and paid that vehicle off in March of this year. Once all debts had been eliminated, they applied the additional money to their emergency fund with a goal of saving $15,000 by this June. They currently have $7,000 in that account. Now debt free, they realize there are other areas that require their focus: retirement savings, financial education, insurance needs, and financing their children’s education.

THE ADVICE
Black Enterprise and Chris Long, registered financial adviser and CFP of Long Financial Planning in Chicago, helped the couple devise a plan.

Emergency fund: Long recommends they use the $2,000 from the Financial Fitness contest to reach their goal of $15,000. “This will help them cover about eight months of living expenses should anything happen,” he says.

Retirement: Cornell and Jammie both want to retire at 55, which Long says is achievable if they don’t deviate from the plan. Cornell currently has $1,078 in his deferred compensation plan. He also has a PEHP-Z 501(c)(9) plan, which can only be used for healthcare expenses once he retires, with a balance of $4,489. He currently contributes $412 a month to his pension plan, which has a current balance of $15,956. Jammie’s company offers a profit-sharing plan and trust that the company contributes to when it is performing well. She has $4,479 in that account, and $2,687 is vested. Employees are not allowed to contribute to the plan.

They would need to save about $25,000 a year in order to hit their retirement goals,” says Long. “Right now, they are saving $2,500 a month, or $30,000 a year.” Out of that $30,000 a year, Long recommends they both open Roth IRAs and put the maximum $5,000 in each. He then says Cornell should put $7,500 into his deferred comp and $7,500 into a low-cost mutual fund such as Fidelity or Vanguard. He suggests an asset allocation mix of 80% in stocks (domestic and international) and 20% in bonds. “It’s better he split it in two places versus putting everything in his deferred comp plan, because it has more than 1% in fees while a low-cost mutual fund can be as low as .18%. Another potential advantage is that capital gains taxes are at a 15% rate and they’ll be taxed at a lower rate than ordinary income.

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Life insurance: Cornell currently has a 20-year term policy for $500,000 and Jammie has $250,000 worth of coverage. They have $10,000 on each of their children as riders. “They need to double those amounts.

Cornell makes $60,000 a year, approximately $48,000 after taxes. If Cornell were to die and Jammie was to live off of that $500,000, it would provide her with about $20,000 a month. If he had a $1 million life insurance policy, that would provide her with about $40,000 a month.” That would be closer to Cornell’s lost income. He recommends the same for Jammie. Long feels that they could make better use of the money that they pay for their children’s policies. “I think they’re just a money maker for insurance companies,” Long explains.

Property casualty insurance: Long recommended that the couple raises their liability coverage; the Brookses

only had the state minimum. Considering how well the couple has recovered, such a move is “penny wise and pound foolish,” says Long. “If they were involved in an accident and someone was injured, $20,000 doesn’t go very far,” he adds. “Now that they have substantial home equity and are developing assets, it’s very important that they increase their protection.”

Finding a financial planner: Although the Brookses are on a solid path, they like the option of being able to consult with a professional for major financial decisions, but are unsure of how to find the best adviser. Long suggests they visit the National Association of Personal Financial Advisors and the Garrett Financial Planning Network. He recommends finding an adviser “who doesn’t get paid a commission and doesn’t sell products. You want to work with someone who has your best interests.” They should also engage in independent research and check advisers out at: SEC.gov, FINRA.org, the Attorney General’s office, and with their state insurance commissioner.

“If [financial planners] get angry, defensive, or try to make you feel dumb, that means they are trying to hide something. You don’t want to work with someone like that,” Long cautions.

Children’s education: Let’s say Jammie and Cornell’s two children, ages 4 and 2, attend the University of Illinois, where annual tuition is currently $26,000 on the main campus. According to Long, the couple could save approximately $13,000 a year (in today’s dollars) if they put $250 into the Illinois Bright Star savings plan. This projection, says Long, is based on a blended rate of return–or 8% in the first several years and 6% afterwards–as well as an annual tuition increase of 5%.