How to Handle a Personal Budget Deficit

If you are spending more money than you're bringing in every month, you've got a budget deficit. You may be making up the difference between your total monthly income and your total monthly spending by using credit cards, getting credit card advances, borrowing money, writing hot checks, paying bills late, or not paying bills at all. Stop doing those things! They’re only driving you deeper into debt.

Cutting expenses

Deal with your budget shortfall, instead, by reducing your spending. Review your budget, looking for expenses that you can trim or eliminate. Focus first on your discretionary spending because those are nonessential items.

It's possible that even some of your fixed and periodic spending items may also be discretionary. For example, cable or streaming TV is not an essential expense. Likewise, you may be able to find a cheaper Internet provider and cancel some of your memberships and subscriptions.

If your deficit is small and most of it is due to waste and fluff, you may be able to move your budget into the black just by eliminating nonessentials. But maybe not. Instead, you may have to go through several rounds of budget-cutting and do some serious belt-tightening before your household’s total monthly spending is less than its total monthly income.

To learn how to take inventory of your total monthly income and spending, see the article "How to Create a Monthly Budget."

Reducing debt before saving

If you contribute to a savings and/or a retirement plan, stop doing that for now. Use that money to cover your living expenses and pay down your high-interest debts. Why? The money in your savings and retirement accounts earns only a small amount of interest each month — most likely far less than the interest rates on your debts. When you have debt, every month you pay more in interest than you can earn in interest on your savings, and you fall further behind.

When your financial situation improves, start contributing to savings and retirement again. But for now, you must put every penny you have toward your essential living expenses and toward paying down your high-interest debts.

Using other strategies

Moving your budget from red to black may require more than budget-cutting alone. The same is true if you can afford to pay only the minimum due on your high-interest debts. When you pay just the minimum each month, it takes months, if not years, to pay off those debts, and you pay hundreds or even thousands of dollars in interest — dollars that you could put to better use.

What else can you do? For starters, you can try these suggestions:

• Increasing your household income: Get a second job, turn your hobby into a part-time business, or let your boss know that you would like to work more hours. If your spouse or partner is not working outside the home, discuss whether a paying job makes sense — at least, until your finances improve.
• Negotiating with your creditors: Some of them may be willing to lower your monthly payments or make other changes to help you afford to continue paying on your debts.
• Consolidating your debts: Debt consolidation involves borrowing money to pay off high-interest debt and lower the total amount you pay on your debts each month.
• Getting help from a reputable nonprofit credit counseling agency: Such agencies can help you develop your budget and may also suggest that you set up a debt-management plan.

Should you file for bankruptcy?

Bankruptcy should always be your option of last resort. When may it become your best option?

• If you’re about to lose an important asset
• If your monthly expenses are so much higher than your income that it will take years of sacrifice and bare-bones budgeting before your debts are manageable and you have a little extra money left over each month

After reviewing your financial information, a bankruptcy attorney can tell you whether you should file for bankruptcy and which type of bankruptcy you can file: a Chapter 13 reorganization, which gives you three to five years to pay your debts; or a Chapter 7 liquidation, which wipes out most of your debts. (To be eligible to file a Chapter 7, you must pass a federally required means test that takes into account your income and your expenses.)

If you decide to file bankruptcy, the attorney will inform you that within six months of doing so you must go to a court-approved credit counseling agency. The agency will make sure that you understand your alternatives to bankruptcy and that there is no way that you can avoid having to file.

If the agency concludes that bankruptcy is your only option, it will give you a certificate that you must provide to the bankruptcy attorney. The certificate permits you to file for bankruptcy. Without it you cannot pursue bankruptcy.

Using standard percentages to gauge finances

Financial experts agree that, in general, your basic living expenses and the total amount of debt you owe (secured and unsecured) should equal no more than a certain percentage of your net household income. (Net household income is your income after deductions for taxes and other expenses — it’s your take-home pay.)

When you’re developing your budget, one way to pinpoint expenses to reduce is to compare your numbers to the following standard percentages. When you have a budget, you can also use the standard percentages to monitor the state of your finances over time.

If your percentages are a little higher than the ones on the following list, you don’t necessarily need to worry because certain expenses may be higher in your part of the country. Housing, for example, varies greatly from place to place. Some financial books and websites also may use slightly different percentages than these; no one correct set of figures exists. These percentages are just approximate amounts for you to use as spending guidelines:

• Monthly housing expense: 25 percent of your net household income (35 percent if you take into account homeowner’s insurance, property taxes, home maintenance, and repairs)
• Consumer debt (credit cards, student loans, medical debts, and so on): 10 percent of your net household income
• Utilities: 15 percent of your net household income
• Transportation: 15 percent of your net household income
• Savings: At least 10 percent of your net household income
• Everything else (food, clothing, medical insurance, prescriptions, entertainment, and so on): 25 percent of your net household income

What to pay down when you can't do it all

If you’ve cut your budget to the bare bones and you still can’t afford to pay all your debts and cover all your living expenses, you have to decide what you will and won’t pay. Here’s how to prioritize:

• Essential living expenses: Your essential living expenses belong at the top of your “bills to pay” list, including putting bread on your table, keeping a roof over your head, keeping your utilities on, and gassing up your car if you need it to earn a living. However, make sure that you have reduced those expenses as much as you possibly can.
• Secured debts: Your secured debts also belong at the top of the list of things to pay. Secured debts are those that you collateralized with an asset you own. This means the lender puts a lien on that asset, which gives the lender the legal right to take it if you fall behind on your payments.
• Certain unsecured debts: These include credit card debt, taxes, federal student loans, child support, health insurance, and medical bills. Some of your unsecured debts should take priority over others.