How to Get Out of Debt (A Step-by-Step Comprehensive Guide)
Getting in debt is easy, getting out of it not so much. Why?
When you make a credit purchase, it is exciting – you get what you are buying, and you hand out a piece of plastic that you even get back. When you have to pay the debt, you get nothing, but you have to hand out your hard earned cash.
This makes paying off debt not simply about numbers that reduce the balance you owe, but an emotional process that can lead to disappointment after seeing much of your hard earned cash going towards covering interest charges while hardly making a dent to the amount owed. That’s not fun.
To help you pay off your debts fast, we’ve put together this simple step-by-step guide which will help you build an action plan that will eliminate your debts. It doesn’t matter if you have low income, bad credit, or are struggling financially, this step-by-step guide will help you pay off your debts fast.
Let’s go through the steps and help you become debt free!
Step 1: Make a List that Summarizes All Your Debts
After going through this guide, many of our readers email us with their comments “I’ll be out of debt in seven months” or “I will be out of debt in 2 years”. Having a plan is critical – it requires dedication, some sacrifice, total commitment, living on a budget, and you have to realize you can become debt free. Just ask yourself, how bad you want it.
Listing out your debts gives you focus and helps you understand exactly where you are financially. Here is what you do:
- Gather your most recent statements for all loans and credit cards.
- Using the below “Debt Payoff Plan”, make a list of all your debts: Include the name of the creditor, interest rate, balance outstanding, and minimum payment.
- Identify how much money you currently have available to pay off debts and where you can cut back on your spending.
- Add up the total of all your debts, and divide the amount by 36. The plan is to pay off the entire total balance in three years, that’s why the number 36 (12*3 = 36).
If you are not sure about what you owe or the interest rate you pay, take the time to find out either by reviewing the statements or by enquiring with your lender. The interest rate and the amount owed are particularly important because they will determine the debt payment strategy you choose.
Don’t ignore the problem
Leaving bills unopened only makes things worse, while interest and penalties keep the balance growing.
Recognize you have a debt problem
One of the biggest mistakes people make is not admitting they have a debt problem and kick down the can hoping the problem will solve itself but it never does. When you admit that you have a debt problem you then start facing the issue head-on and begin to work on an action plan to get yourself back on track.
The point of this exercise is to get a realistic view of your finances and identify what needs to change. Once you know where you stand, you are in a position to do something about it.
Step 2:Create a Monthly Budget
Without a personal budget, it is impossible to live within your means. If you get in debt, over the long run those debts will drag you down; the more you spend to service your debt, the less money you will have available as disposable income.
As you get accustomed to your budget, don’t be afraid to shift money from one category to another. There is no such thing as a normal month. Don’t go on a spending splurge and completely fall off the tracks just because you didn’t accurately predict the cost of a house repair.
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Here is how to start a budget in five simple steps:
1. Figure out how much money you make.
Look up exactly how much you get paid each pay period. This is what you have to work with.
2. Define your core expenses.
Housing, utilities, groceries, insurance – These are the nonnegotiable expenses and must be covered first.
3. Write out your debt payments.
For now, assume you only make minimum payments on all of your debts since that is the amount required.
4. Create categories for regular expenses and assign reasonable spending limits to each item.
Don’t be afraid to have many budget categories. It will help you have a greater understanding of where things are going. Some regular expenses include internet, cell phone, household goods, pets, haircuts, car repair, and home repair. Not every item will have an expense every month, but by setting some money aside for those irregular expenses, you’ll be ready when they hit.
5. Allocate remaining money between debt payments and quality of life expenses.
The money that is left over from your income after completing steps 2 through 4 is what you have to contribute towards your goals and fun. In addition to debt payments, you may want to allow for dinner outs, gym memberships, gifts, etc. Divide the money in the way that best works for you.
Step 3:Choose Between the Debt Snowball or the Debt Avalanche Method
- The debt snowball method
- The debt avalanche method
Debt snowball method
With the debt snowball method, you start paying off the smallest accounts first, while paying the minimum amount on larger debts. Once the smallest debt is paid off, you use those funds and start paying the next slightly larger account.
The secret sauce behind the debt snowball method is the physiological motivation that comes with seeing small accounts being paid off quickly vs. focusing on big accounts that take a lot longer to pay off. When the smaller accounts are paid off, you use the funds left over to pay off bigger accounts creating a snowball effect.
Debt avalanche method
With the debt avalanche method, you pay off the highest amounts to the account that has the highest interest rate and pay only the minimum to all other accounts.
The idea is to target the most expensive debt first. Growing interest can make it tough to climb out of debt, so zeroing in on this debt can help tackle this issue and make real progress.
Since you are focusing on the debt with the highest interest first, the debt avalanche gets you out of debt faster and cheaper, but this method requires a lot more discipline because larger debt might seem insurmountable at first.
ACTION ITEM:Choose the debt payment method that appeals the most to you. Most people find the debt snowball method an easier method to start with because the benefit getting rid of small accounts.
If you have accounts with small balances such as $1,000 balance on a credit card, I recommend you pay those first to get them out of the way (debt snowball); then focus on paying the debts that have the highest interest first (debt avalanche).
Plan your strategy
Once you have decided what debt to attack first (highest interest rate or lowest balance), you will need to create a system that keeps you motivated; the last thing you want to do is start, make some progress and then quit the plan because it is too hard to keep up.
- Determine if you can afford to pay the total monthly payment until your debt is paid off.
- Set up “auto pay” so that you miss payments.
- Pay as much as possible until the debts are paid off.
Give precedence to essential payments such as:
- Your mortgage or rent payment
- Property taxes
- Utility bills
Keeping a roof over your head is your number one priority, and cut back things like entertainment, clothing, shopping, or luxury items do that.
Step 4:Build a Support Network
As the saying goes, “birds of a feather flock together” So if you are trying to become debt free, but all your friends tend to live beyond their means, racking up high credit card balances, then that won’t help.
Surround yourself with excellence, positive influencers and someone who can remind you to get back on track if you yourself happen to go off the rails.
Build a “Keeping motivated” system – something that keeps you happy, motivated, and moving forward.
Step 5:Adjust Your Spending Habits
Keep track of your spending so you can stop bleeding out your cash. One big reason why people end up living beyond their means is that they spend without looking back at what they are spending on.
Every transaction doesn’t necessarily stand out; yet, the credit card statement at the end of the month comes in the thousands. Does that sound familiar?
Try a few small changes like these:
- Use the below daily expense tracker to identify what you are spending on, and evaluate if the expense was a need or a want.
- Give yourself a solid reason to spend wisely
- Research before you shop
It is also important that you find an accountability partner; the problem is most of us can only suppress our wants for so long, and an accountability partner can help us keep on track.
Remember that when you are debt free you will no longer be using your disposable income in paying debts, but would rather be able to keep that money.
See Also: 9 Steps to Achieve Successfully Homeownership (The Home Buyer’s Guide)
Cutting back on essentials
The cost of running a household is significant, but you can find ways to save and free up money that you can allocate to clearing your debts. You should consider the following changes:
- Save on utility costs by implementing energy conservation guidelines
- Downgrade your satellite or cable TV service
- Embrace a frugal mindset but allow some room to regard yourself for every time you achieve a debt payment milestone or goal.
Give up expensive hobbies that are not part of your “Keeping Motivated” system
To stick to a debt payment regiment, you will need a system that keeps you motivated moving towards achieving your goals but do cut back on any hobby that is not part of your “keeping motivated” system. These may include $100 yoga classes, memberships to music download apps, or magazine memberships.
Avoid impulsive buying
Plan your grocery shopping by making a shopping list.Once you’re in the grocery store, stick to your list! If impulse items always end up in your cart, try ordering your groceries online and then picking them up at the store. Oh, and don’t ever shop on an empty stomach; research shows that when you buy on an empty stomach, you tend to overbuy items that will end up in the trash.
Limit night outs and eating at restaurants
It’s true – going to the restaurant is so much easier than cooking at home, but when you do it on a consistent basis, you are wasting a lot of money that could better be used to pay off debt. For a creative way to socialize and share a meal have friends over for taco night instead of meeting up at a restaurant.
Action item:Sign up for a money-saving tool like Trim.Trim is a money-saving tool that sends you updates about your spending via text, finds unwanted subscriptions, and cancels them for you, and can also negotiate with vendors your cable or internet bill.
Step 6:Negotiate a Lower Interest Rate on the Existing Debt You Have.
You’d be surprised of the things you can achieve by simply asking. Here is what you can say when you call the credit card company.
“Hi, I am ________. I have a __________ credit card and have been your client since __________. I have been looking at some credit cards that offer a better interest rate than what my card offers. I’d rather stick to my current card, but the rate is higher than other offers I have seen. Given my payment and credit history, can you help me lower the interest rate that applies to my card today?”
- Move high-interest debt to a loan or credit card account that offers an interest-free balance transfer. Weigh up the cost of balance transfer fees and the likelihood that you will need to switch again when the initial promotion period expires.
- Find out if you can refinance a high-rate auto loan.
By reducing the interest you pay on your debts, you will make your commitments cheaper and have more spare cash to re-direct back towards clearing your outstanding balances.
Step 7:Don’t Acquire More Debt
As you continue paying off debts, avoid the temptation for the instant gratification of making large purchases. When people get in debt they are basically overvaluing the immediate reward of purchasing something they cannot afford today, at the expense of their long term financial health.
A few years back I created a plan for my younger brother to get out of debt; he paid over $20,000 in credit card debt over a period of 14 months, but then he bought a car with a $500 monthly payment. It defeated the purpose.
Save for large consumer purchases insteadof using credit
For example if the car you are driving now has only a few years left before you will need to buy another one, you should start a saving plan that allows you to save an amount per month over a period of time, so that when you need to replace your existing vehicle, you can pay cash for the new vehicle instead of using credit.
For other large purchases, you can set up a special fund such as to pay for vacations, replacing appliances, home repairs, and home renovations.
If you are spending too much using credit cards, switch to cash.
It’s no secret that using credit cards to shop increases your chance of overspending.
Think about this for a second: You need to purchase an item with a price tag of $1,000; what would you find more painful paying in cash at the store, or ordering the item online using a credit card?
Behavioral science suggests, most people would find it more painful to pay with cash at the store; many would even change their mind and opt to buy something less expensive it is meant they had to use their own cash to purchase the item.
This is the very same reason why people find it hard to pay off debt. When it comes to using their own cash to make a payment, the process is a lot harder and painful than simply using a plastic card to shop.
Step 8:Set Up an Emergency Fund
Emergencies can happen, vehicles break down, or an appliance at home may need to be replaced, and if you don’t have the flexibility that an emergency fund can offer, the only other way is to go further into debt.
An emergency fund should cover a total of three to six months’ worth of your monthly expenses. But note, a vacation or a cosmetic home renovation does not qualify as an emergency. True emergencies are unexpected, urgent and necessary.
What’s important is to have the peace of mind of knowing that if something were to happen, you are covered because you have an emergency fund.
Step 9:Increase Your Income
I saved the best for last.The best and fastest way to get out of debt is by increasing your income and using the extra income to pay off debt. You might be thinking if you already have a full-time job, increasing your income might be easier said than done, but it actually can be easily done.
Here are two easy waysyou can increase your income today.
Ask for a Raise
I learned this the hard way; Even if your boss recognizes your accomplishments, he or she won’t give you a raise unless you ask. To get what you want, you have to ask for it.
However, don’t just drop the request in your manager’s lap. Asking is not enough – You have to know how to ask.
To help you with that process, I created an interactive salary negotiation online course. It will only take you 1.5 hours to complete the course, and you will become a savvy salary negotiator.
Register Here:To learn step-by-step instructions how get ask for a raise,or to negotiate a better salary, check out our interactive salary negotiation course.
Start a Side Hustle
Watch how you use your spare time. I would be willing to bet that you can carve out a few hours per week that you can then commit to money-making activities providing a service online.
You can set up a show such as freelance writer, blogger, a web consultant, and much more. List your services on UpWork and start earning.
To Sum Up
The gist of it
The biggest hurdle people need to overcome is in changing the behavior that got them into debt in the first place. Once you’ve done that, it is all about creating a debt pay off plan and attacking debt with everything you’ve got.
If the fight takes longer leaving you exhausted, it is important you implement a “Keeping motivated” system and count on an accountability partner or system that can help you keep on track.
Stay focused on your goal, stick to a budget, trim your spending, and find ways to bring in more income to speed up your journey.
See Also: 9 Steps to Achieve Successfully Homeownership (The Home Buyer’s Guide)