Debt sucks! There is no gentler way to put it.
When the power of compound interest is working against you it can feel like you are barely keeping your head above the water, or worse drowning.
If you are a finally at a place where you have had enough, this guide will help you put together your big plan and finally get out of debt.
1. Plan Your Spending
For the vast majority of Americans their debt problems can be traced directly to their spending habits. Now you may have had extenuating circumstances that led to your eventual debt load, but what that usually means is that your plan had some holes in it and left you open to money problems.
Filling all the holes in our current financial plan requires that we do a monthly written budget. This means that every penny we bring in on a monthly basis has to be spent on paper (or computer) before the month begins.
Let me be honest, the first time anyone does a monthly budget it rarely goes well. For most people it takes around three months to really get this budgeting thing on track.
To get you started I recommend the budget forms you can download for FREE from IWasBrokeNowImNot.com. Not only are the forms comprehensive, they are very easy to use.
If you are trying to budget while living paycheck to paycheck, I recommend using the weekly budget. It will allow you to put each paycheck into the budget on the week you receive it. That way you know which paycheck pays which bills. For those who get paid monthly, you can use the monthly budget and map out your expenses from your single paycheck.
2. Map Your Debt
Now that we have our spending in line, the next step is to write down all our debts in a list. You will want to record the total balance, minimum monthly payment, and interest rate for each debt.
A great tool for helping with this process is the debt freedom date calculator on the IWBNIN.com website. Not only will you be able to plug all your debts into the spreadsheet, you can also get an idea of when you will become debt free.
3. Employ a Debt Reduction Strategy
OK, we’ve got our spending under control with our budget and our list of all our debts. It is now time to employ a debt reduction strategy. We want to be able to focus all our effort on a single debt at a time and get this stuff paid off. There are two main strategies for getting out of debt.
The debt snowball has been made famous by Dave Ramsey, but the concept is much older than his teaching. Once you have all your debts written down, arrange them in order from smallest total balance to largest.
Next, pay only the minimum payment on all your debts except for the smallest one. Throw everything you can at that debt until it is paid off. Once that debt is gone, start on the next smallest debt. This way you take the entire amount you were paying on the first debt and add it to the minimum payment you were making on the second debt.
Keep going down the list until every debt is paid off. Once you get to the final debt you should be making some significant payments.
This method works best from a psychological perspective. When a person has been losing with money for a long time they need to win a few times to start getting excited. When the first few debts roll off you and you no longer have to pay them anymore you feel an energy that helps you get that debt paid off even faster.
Many people think this method doesn’t make sense because it ignores interest, but let’s be honest, if we had been paying attention to interest in the first place would we have this debt?
The debt avalanche is for the person who just cannot ignore the interest rates on their debt. Instead of lining the debts up from the smallest balance to the largest, you line them up from the highest interest rate to the lowest.
Just like the snowball, throw everything you can at the debt with the highest interest rate first and pay the minimum payment on everything else. Every time you pay off a debt roll what you were paying to the next highest interest rate debt.
This method will pay off your debt faster than the snowball, because it takes out the high interest debt first. The downside to it is that you may end up with a really big debt at the top of your list. This means you are going to have to be patient while you pay off that debt and will not get the psychological victories that you get with the snowball.
4. Once on the Plan Consolidate if it Makes Sense
I rarely recommend that people consolidate their debts. The reason is that when going through this process we want to stick to this plan to make sure we are changing our habits forever.
That being said, there are instances where consolidation makes sense. In those cases, I tell people to stick to the original plan for at least six month to get the proper habits in place and then charge up their debt payoff by doing some consolidation.
Consolidating debts will require that you still have good credit. So if you have crashed your credit score during this process it will not be an option. For those with credit card debt you can consolidate with a 0% balance transfer card.
If your debts are larger and high interest you could consider a home equity loan or, if you are 62 or older, you can utilize a reverse mortgage as a revolving credit line. With either one you will get much lower interest rates over unsecured debts. When you use home equity like this, be aware that you are trading your unsecured debt for a secured debt. It is probably a bad idea if you will still be financially strapped after consolidating.
5. Still Feeling a Little Lost? Get Some Help
I didn’t come across this knowledge of getting out of debt through osmosis or divine intervention. I acquired this knowledge by seeking out resources that taught me what to do. My two favorite right now are:
I Was Broke. Now I’m Not. – The team at IWBNIN has a really great book and study guide that can help you get your finances in order. This is the easiest to follow personal finance book I have seen. The reason I put this one at the top is that the book and guide together are only $30. If you want to get the video lessons that are based on the book, you can order the “Leader Kit” for $80. This is one of the least expensive personal finance studies available and it is highly effective.
Financial Peace University – Dave Ramsey has become a household name in the personal finance world. Dave has the third most popular talk radio show in the country and his FPU class is top notch. The FPU kit has a lot of extras that make it easier to follow the plan and once you buy a kit you can join any FPU class across the country. Because you get so much stuff with this kit the cost is $190.
6. Be Patient and Stay the Course
If you have spent years acquiring debt, then it isn’t going to all get paid off overnight. This can be a long slog through the debt repayment process.
Dr. John Maxwell teaches a lesson called, “The Principle of the Five Ax Swings”. It basically paints a picture that you want to cut down a huge tree in your yard and all you have is an ax. If you try to go out and cut it down in one day you are going to wear yourself out, get frustrated, and the tree will still be standing there.
However, if you go out every morning and swing the ax five times, you will not get tired. Eventually that tree will fall and you will have been able to complete the task you set out to do.
The same goes with debt. Stay the course, do the plan, and pay your debts off one by one. Eventually the tree will fall and you will be debt free.
Now go pick up your ax, and take your five swings for today.