How to do Smart Budgeting to Help Debt Reduction

Debt comes to you through three channels.

One, you have borrowed money from a financing source for a specific and well intended purpose which you have to pay back in installments with interest as per clearly agreed terms and conditions. Your monthly pay back commitment is crystal clear; it is mostly by virtue of your earning potential that you have obtained your loans. Example: A home loan or a car loan.

Two, you have borrowed some amount from an acquaintance to tide over an unexpected emergency situation. You have to pay it back, with or without interest, within a time frame mutually agreed by you and your financier.

Three, you keep spending joyfully through your credit cards and when the monthly bills arrive, you opt to pay “the minimum amount payable” and take the rest of the amount into credit, to be paid back later as per the terms of credit card.

When it comes to making a sound household budget and understanding its influence on debt reduction, all the three types of debts we discussed above have a strong bearing.

In your household budget, your committed monthly loan repayment amount from the first type of loans will be one of the clear and prominent items in the list. You cannot wish away this expenditure. This expenditure is like other fixed and non-negotiable items in your budget like your house rent.

When it comes to repaying your casual/ unexpected borrowings falling into the type two category, perhaps you would get tempted to postpone the repayment, because, after all, you got it from a friend who might not sit on your head to get it repaid. Though such an attitude may help you in reducing a yawning gap between income that is less and expenditure that is more, it has every potential to keep you under debt trap for long.

When you fail to repay something that somebody loaned to you in good faith expecting you to repay honestly sooner, you start compromising on your principles and values. Never do that mistake. Any such casual borrowings must be repaid promptly. You must include it in your expenditure item in your budget. If you can’t repay it in one go, you must break it into a couple of installments and be sincere to pay it off every month without being asked.

Now when it comes to the third category of loans, namely uncontrolled spending through credit cards by relying on the deferred payment option given to you by the credit card firm, it is the most potent weapon that can ground you into debt trap with very huge interest burden in the long run.

It is in the above category that your budgeting and discipline to sticking to budgeted spending plays a major role in debt reduction.

Expense reduction — do A-B-C Analysis first

Doing your ABC analysis means rewriting your expenditure list in the descending order of magnitude. Are you aware of Pareto’s law? It says that 20% of your expense items contribute to about 80% of your actual expenditure.

This way, perhaps your rent, food bills and expenditure on your car may contribute to 80% of your actual expenditure in a month (this is just an example; your list may be different). Any economizing on these A-B-C items will substantially contribute to savings in your monthly budget.

Concentrate and Economize on Top A-B-C Items

Again, the prudent thing to do is to prepare a sub A-B-C list of your top spending headings. For example, in your expenditure on car, make an A-B-C list consisting of Gas bill (with separate estimates of regular commuting to office and joy trips), repair/ maintenance expenses, refurbishing expenses etc. If your car expenses on account of unnecessary jolly trips have contributed heavily to Gas expenses and also repairs, this budget analysis will open your eyes to reveal what you have never bothered to quantify seriously so far.

If your sub-list on foods shows purchase of precooked and refrigerated food as the top expenditure item, it is time for you to wake up and spend your time better in the kitchen, following your good old mother’s recipe books! If your spending on fish and meat is excessive, cut it down drastically and learn judicious and tasty ways of cooking vegetarian food. This habit incidentally can help you to cut down your medical bills in the long run!

Luxuries Versus Essentials

The budgeting exercise should also help you in segregating the expenditure into two major groups – Luxuries and essentials. The simple rule is to cut drastically on luxuries and economize nominally on essentials.

A word of caution here. We tend to develop a mindset of bringing in luxury items gradually into essential items over a period of time. In tough economic times, it is essential that your essentials are pruned off from luxuries that have stealthily crept in in the past.

Now armed with these accumulated data, you have to make your new budget. Keep some provision for unexpected expenditure too for the month. Stick to your budget and never get tempted to spend on unnecessary things during a visit to a shopping mall.

Review at the end of the month and make adjustments for the next month’s budget.

You aim in using credit cards must be to pay off the entire amount that comes in the credit card bill on due date promptly.

     To develop this singular discipline, preparing a sound household budget helps a lot. It is not just by preparing the budget but by sticking to its limits that you pave the way for debt reduction.