With the exception of our mortgage, my wife and I have been debt free for over two years. It’s a great feeling. Debt is a burden. It sucks owing someone money. Unfortunately, it has become common place in our society and people can justify almost any purchase. This can lead to trouble when they can’t afford to make some of their payments. When people decide that they need to take control of their finances, debt always seems to be the priority...which is awesome! I love hearing people say, “I’m sick of these payments, I want to get out of debt.”. But how do you actually do it?
It’s simple, right? Just keep making extra payments until your debt is gone. Yes and no. While that is a true statement, it is generally going to take you a long time if you just start throwing extra money here and there without a plan. Let me walk you through my process of getting out of debt.
1. Stop going into debt – This sounds silly, but I’m serious. The first step is making the decision that you won’t go into more debt. This is the most important step because there is no point in getting out of debt if you start maxing out your credit cards down the road. Mortgages are generally the only debt that I would allow yourself to keep using going forward.
2. Decide on an emergency fund – Make sure to save at least $1,000 in the bank before you begin paying off debt. This will protect you from using debt in case of emergencies. You can save more, but once you get more than $3,000, you should probably use some of that to pay off debt.
3. List out all of your debts – Mortgage, auto loans, credit cards, student loans, medical bills, business loans, home equity loans, and even personal loans from family. Find your most recent statement from all of these loans and write down the remaining principal amount due along with the interest rate.
4. List out minimum payments – You must make these minimum payments each month.
5. Create a “budget” – This doesn’t have to be extremely detailed, but you need to figure out an amount of money that you can set aside each month for additional debt payments. These additional payments will be in excess of your minimum payments. This step is important because I want you to have a defined amount each month. If you tell yourself, “I’ll just throw the extra money at the end of the month at my debt” this will take forever.
6. Pick a strategy – What type of person are you?
a. Debt Snowball – You love a victory. You know this will be tough for you and will need motivation throughout. This strategy is for you. Pay off the smallest debt first. Once that is paid off, add the minimum payment from that debt to your monthly amount and attack the next smallest debt.
b. Debt Avalanche – You’re a numbers person. You don’t need victories throughout this process. You just need to know that you are maximizing your savings in the long run. Pay the debt with the highest interest rate first and then move on to the next one. This can be more difficult because it could take a longer time to get that first debt paid off which may cause you to lose motivation. However, it will save you the most money.
7. Hold off on the mortgage – Always save your mortgage for last. Just make your normal mortgage payments. The interest is tax deductible and it is generally(hopefully) your largest debt so I want you to focus on non-mortgage debt for now.
8. Execute – Begin your debt reduction journey.
9. Don’t give up – There will be months when something comes up and you don’t make anything but the minimum payments. That’s fine. Just get back on track next month. Remember, as long as you don’t take out more debt, you are still moving in the right direction.
10. Live debt free – Anyone can do it. You will feel free without those monthly payments. Stay out of debt the rest of your life. A mortgage is OK, but it still isn’t necessary. Don’t be afraid to tackle that too.
Sorry for the longer post than usual, but this is an important one to a lot of people. You can get out of debt! You don’t have to suffer for years to do it. You just need to make it a priority and develop a plan. Don’t let debt payments control your life. It’s just not worth it.
Mike Zeiter, CPA/PFS