Getting out of debt is an arduous and taxing process but ultimately freeing and necessary. People are carrying more and more consumer debt, which harms their ability to live a financially secure life. In order to leave an indebted life in the rearview mirror, look at implementing the following steps:
1. Acknowledge the debt: Instead of throwing away bills without looking at them, organize them on your kitchen table and start adding. Loan and credit card payments should be calculated with essentials bills such as gas and water. If these types of payments already exceed your net income, you will need to find a way to either increase your income (get a second job) or reduce your essential expenses (sell the house, find a smaller apartment).
2. Determine which debts to prioritize: You will want to pay off high-interest debt first (ex. credit cards) followed by non-deductible debt, then low-interest debt, and tax-deductible debt last. Save credit cards for emergencies only and lock all credit cards but one away-don’t close the credit card accounts since that can lower your credit score. You will want to focus on saving for an emergency fund so you will not have to use your credit card in emergencies--make sure to set aside funds every month and focus on growing the balance to cover six months of living expenses. This will ensure that if you have an unforeseeable expense, that you will not have to sacrifice your debt payments, digging you into a deeper hole. The ultimate goal you should strive for is to pay off your credit card in full every month with no lingering balance.
3. Obtain your credit report, which you can do for free once per year. You will want to check for accuracy and also note which accounts are dragging down your credit score. You will want to avoid making late payments on any of these accounts, as it only takes one or two to severely impact your score.
4. Get debt under control: Use automatic payments and tighten up your budget to wrangle in debt. If your credit rating allows, consolidate your debt to a larger loan with a lower interest rate.
5. Consider employing the debt avalanche method or a debt snowball method: The debt avalanche prioritizes paying off the highest interest loans while the debt snowball method prioritizes paying off the smallest loans first with the largest loans last. The advantage of the debt avalanche method is that it saves you the most money in the long run, as first paying off credit card debt with 20% interest vs. a car loan with 6% interest will save you hundreds or thousands of dollars in interest. On the other hand, the debt snowball method may be more motivating as you will reduce the number of loans you have more quickly. Dave Ramsey, a personal finance guru, advocates this method as it helps motivate people to stay on track with their debt repayment plan.
6. Get help: If all of this seems too daunting, you may consider meeting with a credit counselor. Make sure to choose a credit counselor who is rated highly and has your best interests at heart. Avoid ones who charge high fees and churn through clients. You may also consider going to your bank to renegotiate the terms of your debt, but make sure to bring your cash-based budget and practice explaining how you have abandoned your bad credit habits.
7. Bankruptcy: If you can’t dig yourself out, you may have to declare bankruptcy. However, that will ruin your rating and prevent you from taking out loans or credit for years afterward.
Getting out of debt is a long journey, but it is possible. Making a plan and sticking to it is essential to building a debt-free life. Consider rewarding yourself with a fun and little-to-no expense activity once you have reached a milestone--plan a staycation or day at the park with your family.
If you are looking for financial planning services, TABER Asset Management is a fiduciary and financial advisory firm located in Des Moines, IA, serving clients across the U.S.. Contact us at firstname.lastname@example.org or 515-557-1860 for more information on our services.