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Starting out on your debt free journey? Test your knowledge of common financial terms and phrases used to discuss getting out of debt. Each explanation is followed by a tip to help boost your journey. Comment below and let me other terms you want explained.
Cash Only: Cash only means using cash instead of credit cards to purchase goods and services. Studies have shown that people spend more when paying with a credit card. This also applies to debt cards, but to a lesser degree. Using credit cards allows people to delay accountability when making purchases. The act of handing over cash forces people to think over the purchase.
- Slim Fit Wallet Tip: Use the cash only system along with the envelope system to stay on a budget and spend less money. Continue to use a debit account for fixed expenses (ones that don’t change monthly).
Debt Consolidation: Debt consolidation combines several smaller debts into one larger debt, usually with more favorable pay-off terms: a lower interest rate, lower monthly payment or both. Caution: When the debts are combined into one, the lender often forfeits the incentives offered by student loan servicers on federal student loans.
- Slim Fit Wallet Tip: Consider debt consolidation only when the new pay-off terms significantly outweigh the original terms. Debt consolidation does not allow the lender to experience the benefits of the debt snowball method (discussed below) and people tend to lose motivation to pay off debt after consolidation.
Debt Snowball: The debt snowball is a repayment method where all debts are ranked by balance (regardless of interest rate). Minimum payments are made on all debts except the one with the smallest balance. The lender attacks that debt with an additional payment each month until the balance is paid in full. Once it is paid off, the money is rolled into the next debt with the smallest balance.
See the example below. The lender would make the minimum payments on all four accounts, but the account with a balance of $500.00 would be attacked and paid off first (despite having the highest interest rate). After that one is paid off, the lender would attack the account with the $2,000.00 balance.
- Account 1 $500.00 with 10.00% interest rate
- Account 2: $2,000.00 with 0.00% interest rate
- Account 3: $15,000.00 with 6.25% interest rate
- Account 4: $20,000.00 with 0.99% interest rate
End of example
- Slim Fit Wallet Tip: Don’t worry about the interest rate. It is important to feel the wins especially early on. The debt snowball method provides the momentum to get out of debt fast.
Debt Free Visual: A chart or some other visual to help track progress towards becoming debt free. It could also be a visual reminder of the goal to become debt free.
Default Versus Good Standing: Default is the failure to pay on a debt when due or meet the debt’s legal obligations, whereas good standing is meeting the obligations of the debt agreement.
- Slim Fit Wallet Tip: If accounts are in default, it is possible to negotiate a settlement with the debt holder. Be sure to negotiate a settle prior to making payments, get the settlement in writing, and do not allow the debt holder to have electronic access to any accounts.
Envelope System: The envelope system involves storing cash for expenses in physically separate envelopes instead of relying on a debit card or credit card.
- Slim Fit Wallet Tip: Use tiny binder clips instead of actual envelopes.
Fixed verus Variable Expenses: Some expenses such as mortgage or rent are fixed or the same every month. Expenses such groceries are variable and change depending on your use of the products or services. Variable expenses are more flexible and easier to change the cost of compared to fixed expenses.
Free Credit Report: Consumers are entitled to one free credit report from Experian, Equifax, or TransUnion annually.
- Slim Fit Wallet Tip: Request one every four months from one of the three reporting agencies.
Loan Servicer: A loan servicer is a company that handles the billing and other services on a federal student loan.
Repayment Plans: Student loan servicers offer various repayment plans that give the lender the flexibility to change the terms of how the loans are repaid. The terms often affect the monthly payment or how long the lender needs to repay the loan.
- Slim Fit Wallet Tip: When signing up for a loan forgiveness program be sure to enroll in the correct repayment plan. Read and understand the terms of the loan forgiveness program.
Zero-Based Budget: In a zero-based budget income minus expenses must equal zero. The budget is complete when every dollar is assigned to a category. No dollar is left unaccounted. In other words, every dollar must have a specific purpose in the budget.
- Slim Fit Wallet Tip: It is safe to include a buffer line item in the zero-based budget or to overestimate the cost of certain expenses.
By Simone, creator of Slim Fit Wallet
Thanks for reading!