Here is one of the most frequently asked questions in all of personal finance: “How do I get out of debt?” At one level, eliminating debt is simply about following a few steps:
- Stop going into more debt
- Spend less than you make
- Pay off debt with the difference
If you follow these steps, eventually you’ll be debt free. The problem is that following these steps isn’t always so easy. And to make matters worse, there is a lot of “help” out there that can make matters worse. From debt consolidation companies to books like Kevin Trudeau’s “Debt Cures” that I wouldn’t recommend to my worst enemy, there are a lot of promises being made that getting out of debt is easy. It’s not.
In fact, tackling your debt may be one of the hardest things you’ll ever do. You have to control your emotions, which can play a big part in how we make financial decisions. You have to educate yourself about everything from home loans to credit cards to credit scores. And you have to discipline yourself in the way you manage and spend money. The fact is that controlling your spending and paying off your debt is not an easy thing to do. But the good news is that you can do it. If you want to be debt-free bad enough, you can make it happen.
And to help you reach your goal of being debt-free, I’ve assembled a list of 23 tips and tools. If you know of others, please leave a comment at the bottom of this post.
Get to Know Your Debt
The first step in tackling any problem is to fully understand it. When it comes to debt, you should know everything about the terms and conditions of the money you owe. Here are some tips and tools to help you understand your debt.
- Put Your Debt On Paper: The very first step is make a list of the debts you have. The list should include the following information: The name, address and phone number of the creditor; the outstanding balance; the interest rate; the minimum payment; and any other information you feel is important. Even in the age of computers, I like to write out my debt on paper, at least at first.
- Take Advantage of Personal Finance Software: By now many people already have and use personal finance software like Quicken. If so, you can use the tools within the software to record all of the debt you owe and to develop a plan to pay off that debt. As an alternative, one financial tool is designed specifically to help folks get out of debt. Called Ready for Zero, the tool can help you pay off debt faster and build wealth.
- Use Free Online Tools: There are many budget tools available online for free. These tools can track your debt and are easy to use. And it’s hard to beat free!
- Use Free Excel Templates: Microsoft offers free Excel templates that can help you track your debt and a budget. Actually, Microsoft offers free templates for just about everything, including resumes. You can check out the free budget templates here.
- Involve Others: It’s important that your spouse or significant other is involved in the process. If you don’t see eye-to-eye on finances, it can make getting out of debt even more difficult than it already is. It’s not uncommon for one spouse to take the lead in handling finances, and that’s fine. But you both should be on board, particularly as you develop a plan to tackle the debt.
Create a Plan to Pay Off Your Debt
Having written down all your debts, it’s now time to determine how you will go about paying off these bills. A solid plan should not be complicated. It’s simply your approach to tackling your debt. There is no one single approach; you need to do what works best for you and your family. There are, however, some important considerations and tools that can help you develop an effective debt repayment plan:
- Debt Repayment Calculator: As a starting point, it’s helpful (and sometimes painful) to see how long it will take you to pay off your debt if you make just the minimum payments. And there is a free debt repayment calculator that is very easy to use. While the plan will involve making extra payments, the starting point is to understand what you are up against making just the minimum payments on your debt, and this calculator will help you do just that.
- Prepare a Budget: For many, the word “budget” is the dreaded “B” word. But the fact is that you need a budget to control your spending and better manage your money. Remember that it’s the money you don’t spend each month that will go toward paying down your debt. Here are a few budget related articles that can get you started:
- Be Aggressive About Paying Off Debt: Dave Ramsey talks about tackling debt with “gazelle” intensity. It’s about being aggressive in paying off your debt. As you work through your budget, recognize that every dollar counts, and that the more you throw at your debt, the less interest you’ll pay and the faster you’ll get out of debt.
- Be Realistic About Paying Off Debt: While we all want to get out of debt fast, we do have to be careful not to get too aggressive. Paying off debt is a lot like going on a diet. You can commit to never eating foods that are bad for you, but is that realistic? The thought of never eating ice cream is just too much to bear. The same is true with debt. Yes, sacrifices will have to be made to meet your financial goals, but you need balance in life, including your financial life.
- Order Your Debt: With your budget in place and an understanding of how much extra money you can put towards debt, it’s now time to map out a specific plan. The question is this–which debt will you put your extra money toward first? The first thing is not to get too hung up on this question. Depending on your situation, one approach may be better than another, but if you consistently pay down your debt without incurring more debt, you’ll make great progress regardless of which debt you pay first. That said, here are the top three approaches to deciding how to tackle your debt:
- Highest Interest Rate First: With this approach, you put all the extra cash you have on the debt that has the highest interest rate. This approach will result in the lowest interest charges and the fastest debt repayment possible.
- Smallest Balance First: This is the Dave Ramsey approach. He suggests targeting the debt with the smallest balance first. While that debt may not have the highest interest rate, the theory is to get one debt paid off as fast as possible. The rationale is twofold. First, paying off a debt gives you a feeling of accomplishment, which may be just the motivation you need to keep on track. Second, by paying of a debt completely, you free up the cash that was needed to make monthly payments to that bill. While you are likely to put that cash to the next debt, in an emergency, you could use it for other purposes. In other words, by paying the smallest debt first, you free up cashflow.
- Non-Revolving Debt First: While many talk about the two approaches above, few look at the type of debt when deciding which one to pay first. Recall that revolving debt, like credit cards, allows you to borrow again after you’ve paid down the debt. Non-revolving debt, like a car or school loan, does not permit you to borrow again as you pay down the debt. With a car loan, once the debt is paid, the loan is gone. With a credit card, once the debt is paid, the card is still there to use again if you so chose. For this reason, I’ll often focus on non-revolving debt first. Why? Because I can’t go out and charge up the debt again once it’s paid. This is purely a pyschological issue, but an important one, particularly if you fear you may lack some discipline once some of your debt is paid off.
- Don’t Forget Your Emergency Fund: An emergency fund is a really important part of a debt elimination program. While you may be tempted to put 100% of your extra cash toward debt, keeping at least some of it aside for emergencies will help break the reliance many have on credit. When the car needs new tires, it’s better to turn to the emergency fund than it is the Visa credit card. I’ll also add that while you can use a high yield savings account for your emergency fund, a short term, high yield CD may be the better bet. Whle most CDs do charge a penalty if funds are withdrawn before the end of the term, that penalty can help keep you from accessing the funds for anything other than a true emergency. In addition, there are short-term CDs available with 3 or even 1-month terms.
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