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How to get out of debt, is probably not something you search for casually. It’s usually when you feel stuck. You want to do things, or you see other people doing things, and you realize you can’t.
We’ll always have the occasional emergency, like the car breaking down at the worst possible time. But those are usually fixed in a day or two.
The problem with debt, is that it sneaks up on you until you suddenly realize that it too, is an emergency. But getting out of debt will take longer than a few days to fix.
So here, we’ll lay out a simple plan that’ll not only help you eliminate debt, but enable you to avoid it in the future.
How to Get Out of Debt
What’s the Rush to Get Out Of Debt?
Whether you like your job or not, the reason we spend a third of every day there, is so one day we can call it quits and do whatever we want. And hopefully, that day comes while we’re healthy enough to actually enjoy it.
So how much do you really need to save?
Well, depending on the standard of living you expect to have, let’s try using the 4% rule. This pretty widely used estimate says, that you can safely withdraw 4% of your savings in each year of your retirement, without running out of money.
Your total savings:
- $500k – 4% a year is $20k.
- $1 million – 4% a year is $40k.
- $1.5 million – 4% a year is $60k.
- $2.0 million – 4% a year is $80k.
So, it’s easy to see, that you’ll never be able to walk away from work completely, unless you have some serious cash saved.
One big milestone, is getting your first 100k saved. Because once you do, now you have the magic of compound interest helping you. Saving from 100k to 200k takes less time than it took to get to 100k. And getting from 200k to 300k, even less time, and so on.
But the key is getting started. If it takes two decades to save the first 100k because you’re stuck in debt, that’s a problem.
Whether it’s car payments, furniture payments, a high mortgage – if you can’t afford to put away a minimum of 10% of each paycheck, before any bills are paid, then debt is a problem that’ll get worse each year.
Take a Step Back and Understand How You Got Here
If debt is a real problem for you, then understanding how you got here might help to motivate you to fix your situation.
Granted, we do pay for a lot of things – cable TV, cell phones, wifi etc, that society considers “necessary” that weren’t even around a generation ago.
But there’s another way debt sneaks up on you.
Try spending an hour browsing through your Facebook feed, and there’s a good chance you’ll come away wondering what’s wrong with your life.
One friend is lounging on a beach in Mexico. Another friend is checking in from dinner and drinks at a nice restaurant, or a concert or sporting event. Someone else is anchored in the bay on a beautiful afternoon.
See the pattern?
We’re only seeing the highlights. We have no idea how our friend paid for her vacation, or dinner, or the concert. For all we know, they could be in debt up to their eyeballs.
But by seeing little snippets of everyone’s life – only the good parts of course, it’s easy to be convinced that something’s missing from our life.
FOMO is powerful when we start fixating on everyone around us, and it’s easy to start reaching for, and buying things that make no sense for us. So much so, that according to CNBC, 40% of citizens can’t cover even a $400 emergency.
What Will it Take to Get Out of Debt?
Oprah Winfrey once said,
“People who get what they want, tend to be the ones who know what they want”.
And I might add to that…
“and make the decisions each day that move you in that direction”.
By “knowing what they want”, she was referring to longer term goals. Something you might want to see materializing in your life within the next 3 to 5 years.
Working to pay the bills is urgent. but what’s important to you?
The motivation to get out of debt, and stay that way, is gonna take more than just throwing money at your Visa bill.
Here’s an example:
Suppose I’m dating someone, and we take a vacation to Charleston, South Carolina. We’re planning to get married in the next couple years, and we both loved Charleston so much, that we’d like to start our life together there.
But right now, we each owe over $10k in credit card debt. We’re paying a student loan too, and we each have car payments.
But now we have a common goal. Something we both want more than anything else.
Now when we browse through our Facebook feed, and see our friend on the beach in Mexico, or our neighbors dining out for the third time this month, it doesn’t bother us.
Those things are nice, but we’re not tempted now, because we have our own goal. Our long-term goal to move to Charleston is now our north star, that guides every spending decision we make for the next couple years.
Now it becomes easy to say no thanks to the things that might be nice, but for now, aren’t right for us. We have our own direction.
Where do you want to be in 3 to 5 years?
- In another job? Maybe one that requires more training?
- In another home?
- Debt free with XX dollars saved?
- Finally launch that side business you’ve been kicking around?
It’s urgent to get up and go to work each day. But it’s important to have a reason. Something that you, yourself want, and are working towards. That’s where the clarity comes from when you’re faced with 1001 things all competing for your paycheck.
What’s the Method?
So now, we have a good idea of what got us into debt. And we know that time is critical. If we spend the next decade living paycheck to paycheck, it’s gonna seriously affect our life later.
But we need a strategic plan to get from point A (now), to point B (debt free)?
Well, like any other journey, you need to know where point A is. Then by carrying out some specific steps, we’ll start heading to point B.
To figure out where we are now, we need to know how much money is coming in, and exactly where it’s going.
So step 1 is:
Write a Simple Budget
Writing a budget doesn’t need to be complicated. Just get out a notebook and write down your total monthly income. Then list each bill you pay, and the amounts.
Got your bills listed?
Good, now you’ll need your bank statement. You want to capture every nickel you’re spending, and put it into a category.
Don’t be surprised, if your expenses are higher than your income. It happens. But we’re gonna start reversing that.
Have a budget meeting
Now that you know where your money’s going, you’ll need to make some decisions on where you might cut back. So if this is gonna affect your lifestyle and your spending, you want to have buy-in from whoever else spends money.
You want to agree that from now on, things will be different. Not worse, just different.
If you live by yourself, this will be an easy meeting. Maybe you can invite the cat over. But dogs are more agreeable.
Whoever you live with, try to agree that once a week you’ll get together for 15 minutes to have a low-pressure talk about how you’re doing.
It’s just a time to discuss things like:
- Did we stay within our budget this week?
- Are the budgeted amounts working?
- What’s happening next week? Any work lunches you need to plan for, or birthdays you’ll need a gift for? Does the car need an oil change?
- Having this short, low-pressure get together reinforces the fact that you’re heading in the same direction, and there are no surprises to throw you off-track.
Start an Emergency Fund. Like Today.
This is a simple concept that prevents so many people from getting out of debt:
Your checking account should be for budgeted money, and maybe a small buffer. You need a separate account for emergencies.
The whole point of writing a budget is to be able to budget. So that means only your predictable expenses. When you suddenly throw a $900 car repair into your carefully planned budget, one of two things can happen:
- You’ll skip a few few bills, and maybe spend every last dime trying to pay for the emergency.
- Or you’ll charge it on a credit card.
This is what makes people throw up their hands in frustration and give up.
I thought for years, that I couldn’t afford to have an emergency fund, but that’s bullshit. You can’t afford not to have one.
If you’re really struggling with debt right now, forget about the recommended 3 to 6 months of expenses. But you’ve got to do everything in your power to get $1000 into a separate account.
Whether it’s a brake job on the car, a medical expense or some other emergency – the next one will come when you least expect it. And the last thing you want to do, especially now, is to add to your debt.
I found a way to build an emergency fund in very small increments, and have it done automatically. I barely notice the contributions, and as of today I have $931.04 in it.
Most emergencies are less than $1000, so getting that into a separate account is huge. If you want to get out of debt steadily, without future emergencies wiping out your progress, you absolutely need to be able to pay cash for them.
You can do this!
Start Attacking Your Debt
So we know where our money’s going, and we’ve started an emergency fund. We’re ready to start crushing our debt.
Now we need a plan.
Two popular get out of debt methods, are the debt snowball and the debt avalanche.
They’re similar, in that you pay minimum payments on each debt except one. On that account, you pay every penny you can, until you eliminate it.
Here’s the difference:
The Debt Snowball:
You’d pay the minimum payment on each account except the one with the smallest balance. On the account with the smallest balance, you pay the minimum, plus every extra dollar you can, until you eliminate it.
The debt snowball’s advantage is that you get quick wins by paying off smaller accounts faster. It’s a psychological boost, and a motivator.
Then once we eliminate the smallest debt, we focus on the next smallest:
The Debt Avalanche:
The debt avalanche uses the same systematic approach, except that you’d pay the minimum on each account except the one with the highest interest rate. For that one, you’d pay every dollar you can, until you eliminate it.
Then you’d continue to pay the minimum payment on each account except the one with the next highest rate. And you’d continue this pattern until you get out of debt completely.
It’s possible that the debt avalanche may save you some money in interest payments. But if you’ve been struggling to eliminate debt for awhile, the debt snowball could be more motivating because you’ll see results faster.
I’ve used the debt snowball to get out of debt, and I can say that it is very motivating to see those quick wins.
Whichever method you use, try to remember:
- Be consistent. Keep hammering away.
- Have your weekly budget meetings to make sure everyone is on the same page.
- You don’t need to wait until the due date to pay a bill. If you get a bonus, or a gift, go online and make a payment right away.
Use Your Budget as a Tool
Once you open your emergency fund, and start either the debt snowball or debt avalanche, you might find you’re only able to pay a small amount towards debt each month.
Don’t be discouraged. You can use your budget to find extra money by pecking away at your monthly expenses.
- Add up everything you spent on food last month. Groceries, take-out, restaurants, work lunches. The total might surprise you. But here’s a way you might save several hundred dollars pretty quickly.
- Do you pay for cable TV? If you do, you’re paying for dozens of channels you never watch, and you’re probably throwing money away to rent their equipment. Here’s how we canceled cable and watch the same content for over $100 less each month.
- Look for patterns with your spending. When does it seem like you spend the most? On the weekends maybe?
- Are there any habits you might be able to cut back on temporarily, like paying for the gym?
- Do most of your payments fall in one half of the month? Try changing some of the due dates.
- If you need to bring in more income, here are some side hustle ideas.
Don’t worry that your first crack at a budget shows that you’re living way beyond your means. That’s exactly what it’s for.
Getting out of debt is like having a clogged toilet. Everybody knows there’s a problem, but no one wants to go in there. But sooner or later someone has to. Today, we’ve grabbed the plunger.
Whichever method you use, it’ll work as long as you’re consistent.
Keep having your budget meetings. Be focused on your goal. Make it a game to find things to do that are free or low-cost. .
What to Do After You Get Out of Debt
When you finally make that last debt payment, it’s time to celebrate. Cheaply.
By eliminating those monthly payments, you’ve opened up a lot more possibilities in your life.
- If you want to transition to another career, you’ll be able to afford some training.
- You can actually save money and feel more secure.
- If you have a hobby, you’ll be able to spend a few bucks on it.
- When the car breaks down, it won’t ruin your week. Or your month.
Once you’re done celebrating, there’s a few things you’ll want to do now that you’re debt free:
- Get a credit report. Chances are, there’s some negative information in yours, especially if you were using more than 30% of your available credit. Now you can make sure it’s correct. Most credit reporting agencies (including AnnualCreditReport) will give you a summary, but not your FICA score unless you pay for it. Here’s how you can get your credit report and your FICA score, both for FREE.
- Keep building your emergency fund. When you get to the point that you have 3 to 6 months expenses, then you can start ramping up your retirement savings. Remember, that first 100k is the hardest, but after that…you’ll see it grow quicker.
Having a personal goal, or a joint goal with your partner is a key to developing the mindset you’ll need to get out of debt. Spending decisions come at us multiple times a day. So your decision process can’t be:
Do I have the money in my account today?
It needs to be:
Does this make sense for me at this point? Even if my debt is paid off, is this contributing to the life I want?
You’ll always see your friend’s Facebook feeds, showing the highlights of their lives. Do you deserve that Mexican vacation, or the concert tickets, or the dinners out?
Of course you do!
But what you really deserve, more than anything else, is to have a plan – one that’s right for you and your family.
A plan that’s protecting you from emergencies, and moving you closer each day to your goal.
When you put in the work to become debt free, your opinion of consumer debt will probably change. You’ll stop looking at debt as a solution to problems, and start seeing it as a problem to be avoided.
A debt reduction and life plan doesn’t mean you’ll be living the life of a monk. It just means you’ll spend money intentionally, and according to your own values. You’ll make temporary sacrifices, but over time, you’ll have a lot less regrets.
How about you? Are you in the process of reducing debt? Has anything worked well for you?