How to Become Debt Free–A 5 Step Approach

In this second article in our series on Financial Goals for 30-Somethings, we look at debt. Most of us have debt in our 30s. From mortgages to school loans to credit cards and car loans, some have lots of debt in their 30s. Today, we are going to look at how to become debt free.

Now, you may have noticed that I talked about retirement savings in the first article in this series. Contrary to some, I believe that saving for retirement should be our primary goal, with getting out of consumer debt a very close second. Why?

The key to a successful retirement is starting to save early. We need the power of compound interest to kick in to grow our savings to 12x our income, or whatever number you’ve chosen. For compound interest to kick in, we need time. Lots of time. As a result, we can’t lose a decade or more in retirement savings while we pay off all of our non-mortgage debt. The key to this approach is to keep the interest rates on your debt as low as possible, which we’ll cover below.

With that said, let’s look at some key debt related goals for those in their 30’s: (1) avoiding debt, and (2) getting out of debt.

Step 1: Spend Less Than You Make

The absolute first step to getting out of debt is to stop going into more of it. There are two reasons this is so important. First, and most obvious, you can’t get out of debt while your credit card balances are going up. Second, the money you have left over at the end of the month can be used to supercharge your debt snowball, which we’ll talk about below.

The purpose of this article is not to dive into budgeting, but here are some resources that can help you keep expenses less than your income:

Step 2: Get a Snapshot of Your Debt

The next step is to collect information about all of your debts. For each debt, you’ll want to get the name of the creditor, current balance, interest rate, and minimum monthly payment. I like to put all of this information in a spreadsheet, which would look something like this:

CreditorBalanceInterest RateMinimum Payment
Credit Card #1$5,00012.99%$100
Credit Card #2$2,50014.99%$50
Credit Card #3$1,0009.99%$25
School Loan$20,0007.00%$250
Car Loan$12,0006.99%$300

The snapshot is important for several reasons. First, we’ll use the interest rates of each loan to determine if we can benefit from refinancing (see Step 4). Second, we’ll use the minimum monthly payment as part of our debt snowball analysis (see Step 5). And finally, we’ll use the balances of our debt to create “small wins” to help motivate us to keep on track (see the Power of Small Wins below).

Step 3: Eliminate Debt

The get out of debt articles I’ve seen totally miss this critical step. Are there any debts you can simply get rid of by making some tough choices? For my wife and I, we sold a fancy car we didn’t need and I gave up membership to a country club I never should have joined in the first place. You may quickly conclude that getting rid of some debts is not an option, but it’s worth considering carefully before moving to the next step.

Step 4: Lower Your Interest Rates

For those debts you can’t eliminate, reduce the interest rate you are paying as much as possible. Every single type of debt can be refinanced, from credit cards to school loans to car loans. Refinancing isn’t just for mortgages.

Look at each debt on your snapshot and determine if you can lower the interest rate. In some cases, you may be able to get a lower rate simply by calling the creditor. it’s worth a few minutes of your time. Keep in mind that lowering the interest rate has the double benefit of reducing your interest expense and getting you out of debt faster.

The one type of debt that typically comes with the highest rates is also the easiest to refinance–credit cards. My wife and I used 0% balance transfer cards over the course of about three years to climb out of debt. When the zero percent introductory offer expired on one card, we simply rolled the balance over to a new card.

One thing here is critical. We are only using 0% offers to transfer existing debt to take advantage of no interest. We are not using 0% offers to go into more debt. For example, you may have seen 0% for 12 month deals at furniture or electronic stores. That type of offer is completely different than a balance transfer, because with those deals you are borrowing more money to buy stuff you can’t afford.

Dave Ramsey, the king of cash, recognizes this difference. He’s okay with balance transfers; he’s not okay with 0% deals that get you into more debt. I totally agree.

Step 5: Pay It Down–Debt Snowball

Now the fun begins. You’ve eliminated any debts you can. You’ve reduced the interest rates as much as possible. Now it’s time to start hacking away at the debt.

Let’s assume for the moment that all you can afford to make is the minimum monthly payments. We’ll use our example above, which had a total minimum payment of $725 a month. Using the debt snowball, you’ll continue to pay $725 a month until ALL of your debts are paid off. That means you’ll continue to pay $725 even as your minimum monthly payment goes down. Your minimum payment will go down for two reasons.

First, it will of course go down as you pay off debts. Second, it will go down as the balances on your revolving debt (mainly credit cards) goes down. This happens because most credit cards calculate your minimum payment as a percentage of your balance. As your balance goes down, so does your minimum payment.

The key, however, is to keep paying $725 a month regardless of what the credit card companies say you must pay. To give you an idea of just how important this is, let’s assume you have a $5,000 credit card balance at 15% interest. Let’s further assume that your current minimum monthly required payment is $100 (2% of $5,000). The following table compares using the debt snowball method (paying $100 a month until the debt is gone) versus making the minimum payment each month:

 Debt SnowballMinimum Payment
Total Interest Paid$2,728$7,652
Time to Pay Off Debt78 Months463 Months

You may be wondering just how the debt snowball can save so much time and money. It may be easier to visualize with the following screenshot that shows how your required payment goes down over time:

Minimum Payment Schedule

Source: Debt Snowball Caclulator

The Power of Small Wins

Now the big question. If you have extra money to put toward your debt, which one should it go towards? There are two approaches to this question: (1) Put the extra cash toward the loan with the smallest balance, or (2) apply it to the loan with the highest interest rate. Some call the second approach the “debt avalanche.”

The rationale for the first approach is motivational. By paying off a loan quickly, you get a small win that helps motivate you to stay on track. In contrast, by tackling the loan with the highest interest rate first, you save on interest and get out of debt more quickly.

So which is the right approach?

If you’ve done a good job of lowering your interest rates, frankly, it doesn’t much matter. A one or two percent difference over a relatively short period of time isn’t going to have a significant effect. If, on the other hand, you are paying double-digit rates, which approach you take could make a huge difference. Tackling high rate debt first can save a ton of money and help you get out of debt a lot faster.

Still, small wins are very important. Study after study shows that quick victories help keep us motivated and on track. Paying off a debt completely, however, isn’t the only possible small win. For me, just watching my total debt go down is a victory. I found that updating my debt snapshot every month and watching the total balance cross key thresholds was sufficiently motivating.

Final Thoughts

Getting out of non-mortgage debt is key to achieving financial freedom. It’s a great goal at any age, but particularly in your 30s. If you can emerge from your 30-something decade with no consumer debt, you’ll be in an ideal position to maximize savings during your high-earning 40s and 50s.

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2 Responses to “How to Become Debt Free–A 5 Step Approach”

  1. Ashley-elora

    I just stumbled upon your website,as a 27 year old adult college student (3 years left for a PharmD degree, that I commute 4 hours a day to get because its the closest college and I can’t afford to live in NYC) paying out of pocket for whatever my scholarships and loans don’t cost with a really terrible paying ($10 an hour 25 hours a week, 45 minutes away job) it helps explain a lot. Although I am still having issues on how to tackle my situation financially, like juggling saving just in case, saving for life, paying my loans, trying to feed myself.

    Out of curiosity when I pay my emergency credit card monthly I always pay atleast $10 or so dollars over the minimum. For some reason I always thought that positively affected my credit rating instead of just chipping away at the balance. Is that not true? Should I just pay the minimum, save the extra I was going to pay and save it for the future instead?

    I don’t really know how that works.

    Thank you in advance!

    • Rob Berger

      The amount you pay on your credit card should be based first and foremost on getting out of debt. If you can reduce your interest rate with a 0% card you should. Unless you plan on buying a home soon, your credit score shouldn’t be the number one priority when setting your monthly payment, in my opinion. That said, reducing your credit card balances will, over time, improve your credit score, all other things being equal. You may not, however, see a big change from month to month.

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