Prompted by a recent e-mail from a reader and the opportunity to meet with a family member to discuss personal finance and how to get one’s budget on track, got me thinking of the overall steps on how to get out of debt. It made me realize in my close to year and a half blogging I’ve never really posted an overview of how one might get started to climb their way out of debt or getting their money to work better for themselves. Sure I’ve covered parts of our plan on our journey to pay off $109,000 worth of debt, but never the step by step. So here it is my best advice for someone looking to kick-start debt repayment, or get the old budget back on the rails.
Debt Freedom Steps
I’ve tried to list the steps in chronological order; the one that could be placed anywhere and everywhere is communicate. As you read my advice I think you will see why.
My overall knowledge of personal finance began over five years ago. I knew we were in trouble months before we got our act together in June of 2010, I just never admitted before that time that it was a real issue. That’s the first step in my opinion, realizing you need help and will to accept help from others.
Realize you need Help – Once you accept this, it is easy to move on to the next steps. Once I accepted we needed to make a change I began to read everything and anything I could get my hands on about personal finance, including many blogs and books. Dave Ramsey’s “The Total Money Makeover” remains my favorite and it’s a book I have gifted to people over 30 times.
Build a Plan – Now that you’ve mentally and emotionally ready for the change you need to build a plan. The best way is in a form of a budget. I stared mine on an excel spreadsheet and still use it today. You can jot it down on paper, use an app or software like Personal Capital, but whichever way you choose you need to get your total income, debt and expenses down in some format.
A budget could take time to evolve, you may want to track your spending for 30, 60, 90 days saving all receipts to see where your money is going. You may be surprised at some of the dollar amounts of some categories, they could be much higher or lower than you originally estimated. This is why tracking all spending over a period of time is helpful.
Communicate and agree on the Plan – It’s so important to be on the same page with your spouse, partner, children, etc. when making changes like this. I was the one who initiated the plan for us, but before we started anything I reviewed it with my wife. We compromised on some things, but came away with an agreement on our money and budget that we were both in sync with. Then, we looped in our three children so they were aware of the changes and to help start to educate them about all things personal finance related. Communication is not just a one-time thing, it’s ongoing every day. Our family talks about money and budgets all the time. It’s the way we’ve stayed on track for over four plus years.
Stop building New Debt –Once you know you’re overall numbers you can begin to move forward on taking action. If you have debt, the next step is to stop accumulating any new day, not tomorrow, not next week, but today! You don’t want to dig yourself further into a hole, you want to begin climbing out immediately. We did this by cutting up our credit cards and only using cash.
Wants versus Needs – Once you have a clear understanding of the budget and all expenses, it’s time to priority the expenses into two buckets either a want or a need. Food and shelter are clearly needs, the new 60 inch television or pair of shoes is wants.
We were able to cut a number of wants out of our expenses things like satellite radio, eating out, and entertainment to help cut spending. These cuts become extra money now in your budget that can be used to pay down your debt.
Emergency Fund – Or the peace of mind fund. You need to have some type of cash saving for when life happens or Murphy come to visit you. We never had an e-fund before 2010, and when an appliance broke or we got a flat tire it was stressful. We didn’t have a plan for these things and we had to scramble to find the money to pay for it or use a credit card. A $1000 saving will cover must events and reduces so much stress and avoid money fights you’ll have no idea until you have the e-fund in place.
Debt Snowball – The debt snowball is the method we chose to pay off our debt. The debt snowball is a debt reduction method where one owes on more than one account and pays off the accounts starting with the smallest balances first while paying the minimum on larger debts. After the smallest balance is paid off, the payment is snowballed to the next smallest debt. This method helps build momentum. This worked best for us. Others use the Debt Avalanche method where you pay off the balance with the highest interest rates first. Anyway you choose to pay off your debt is fine, as long as you are not adding any new debt along the way and adding as much additional money as possible to your repayment is the key.
One piece of information I found interesting is that most banks and credit unions offer free credit counseling. Check with yours, they can supply you with additional advice and information that you may find helpful. You can always speak with you creditors yourself and request an interest rate reduction. The best approach is to be honest and be diligent. Don’t give up after the first “no.”
Build Wealth – Once you have completed your debt repayment, you will now have a surplus of income each month to do what you want with. I would recommend building wealth, by increasing emergency fund saving to cover you for when bigger life events happen. Could you survive a job loss? Build retirement saving, by investing. Save money for college, a house, a vacation, a car, etc. The possibilities are endless once you free your income up to spend on your priorities and not minimum payments.
Now these steps that I’ve outlined will not be easy. They will take sacrifice. We averaged a $2180 a month debt payment for 50 months in order to achieve our goal of becoming debt free. It was tough to do at first. We cut corners, we took on extra work, we often had to tell our three children “no” when they wanted to go do things. In the end the short-term sacrifice was worth the long-term goal of being debt free. Now having a surplus of over $2k per month we can do just about anything we want. If not, we just save our money for a few months and the possibilities are endless.
I hope this information is helpful, it’s been a blessing for my family. Please comment or contact me if I can help you or your family in any way.