Thursday, August 20, 2015

Paying Off $30k of Debt in One Year

I've had a lot of good responses from my post a few weeks back, and I really need to be a bit more consistent and frequent with my updates. Life has been a tad busy helping my parents move, so I haven't had a chance to write much.

Most people are anxious to know more about how I managed to live in my car. Where did I shower? How did I sleep? Where did I keep clothes? Honestly, I should have answered these questions long ago, but I never spent the time to take quality pictures and document things as well as I would like. I fully intend to answer these questions, but today is not the day, and I have something to share that I believe is far more important and helpful.

The first year I decided to live in my car, I was focused primarily on paying off my debt. I had college and car loans that amounted to roughly $30k, and I would spend just about my entire paycheck to get rid of it. Being an engineering-minded individual, I like to be as efficient (lazy?) as possible. There are a number of debt payoff and consolidation methodologies out there like tackling the largest loan first, consolidating debt to the smallest interest account, etc. While some of those ideas have their merits, I went about things a bit differently.

By way of example, let's pick on the "largest loan first" methodology. Say you have a $10k loan at 2% and a $2k loan at 8%. With this methodology, you should pay the minimum to the $2k loan while allocating as much money as you can to the $10k loan. Sure, this is a simple way to attack the problem, but there is one little flaw, here: interest is not being taken into consideration. The biggest loan also has the lowest interest. As Einstein supposedly once quipped, compound interest is the most powerful force in the universe. While you're busy chipping away at the $10k loan, that $2k loan is growing at an advanced rate.

So, what am I suggesting - pay off the highest interest first? No, by doing so, you introduce the same problem, only in reverse. As you're rapidly paying off the smaller loan with the highest interest, the effect of the 2% interest on the other loan is multiplied by the large principal. Once again, interest is not your friend.

What I did is put together this spreadsheet that calculates what percentage I should allocated toward each loan by weighting the principal and the interest together. This way, I'm chipping away at all loans equally regardless of the principal size or interest rate. By the time I paid off my debt, I paid off all of my loans on the exact same day because I was paying them off in parallel. It worked pretty well, and while I could have done some consolidation work to get rid of higher interest loans, I think this is one of the most logical approaches to paying off debt.

There is a downside with my methodology. In order take this approach, you often need to allocate a lot of extra money to certain loans when taking into account the weighted percentage, and this may go far beyond what the average person is able to pay in a given month. Therefore, I added some extra calculations to my spreadsheet to take this into account. Once you populate the principal, interest rate, and minimum payment fields for each loan, the most efficient total amount of money is calculated. If the total payment that you are able to make is below this amount, then the spreadsheet will adjust by only making minimum payments to certain lower principal/interest weighted loans and splitting up the remainder amongst the rest. It's not as efficient, but it takes into account the reality of most peoples' lives.

I'd really like to try to add in things like investment accounts into the mix. For example, if you want to add $5k to a Roth IRA over the course of the year, it makes sense to allocate more toward the end of the year and less at the start so you can focus on paying off loans. However, investment accounts do appreciate at a (fairly predictable) rate, and there is still something to be gained by putting away money earlier rather than later. Maybe I'll figure out how to add that to my spreadsheet later on, but for now, I've had enough with formulas for one day . . .

One final note. My spreadsheet is obviously rather static in nature. The principal and interest rate for a particular loan is recorded for a snapshot in time, and the principal is not recalculated based on elapsed time. It may be necessary to update these fields every month especially if you can't allocate the full and most efficient amount as calculated. Things will get out of whack, and you may not be doing things as efficiently as possible.

Well, that's it! That's how I managed to pay off my debt, and I hope it helps some of you out there. I'd really like to make an app out of this, but despite my technical background, I've actually never written an app in my life. If anyone is interested in helping me create one, that would be pretty fantastic.

For those of you who missed the link to my spreadsheet: