How to Get Out of Debt

    Mounting debts can undermine borrowers’ well-being and even derail their life plans. The metaphors commonly used in describing it – quicksand, a prison sentence, overwhelming burden – paint a bleak picture that feels like it will last a lifetime.

    Yet not all debt is negative. Good debt, called leverage, is money that you borrow to finance an appreciating investment. Home mortgages usually are good debts since the value of your property tends to increase as your mortgage shrinks. Student loans should fall in this category, if you can earn a college degree and turn that into a job.

    It’s the other variety, bad debt, that gives the word a bad name. Bad debt can quickly grow from nuisance to monster. Credit card debt is far and away the most common. Auto loans are a close second. Gambling, vacations and weddings are three more sources of bad debt and credit cards usually get a workout in all three.

    Using plastic to make purchases is so easy, and paying the minimum balance each month requires so little effort, that bad debt piles up. Before you know it, interest payments become so huge that you’re spending most of your paycheck on finance charges.

    What can you do about it if you get caught in the debt vice? The most important step is to figure out how much you owe and what you can do to eliminate it.

    Here are five steps anyone drowning in debt should take to get out of debt:
    • Accurately assess the status of your debts from amount owed, to interest charges to expected pay off dates.
    • Make a budget. Use it to guide and track spending.
    • Create more income. Get a second job.
    • Stop borrowing and using credit cards. Cash only.
    • Change debt-enabling habits. Drastically reduce dining out, entertainment expenses.

    These are all good habits that take time and discipline to put in practice, but each one is a necessary component if you’re serious about eliminating debt.

    Assess Your Current Debts

    One of the first steps to get yourself out of debt is knowing how and why you got there. If your debt load is too heavy, ask yourself, “How did that happen?”

    It’s important that you have a clear starting point about how much you owe and where you’re spending money. List all your expenses from the previous month, add them up and compare them to your income. The goal is to make the two columns balance and eventually tilt in favor of income over expenses. If you can’t pull that off, ask yourself why.

    Does the spending list show a lot of trips for fast food, restaurants and specialty coffees? Or does it show money going to doctors and medical emergencies? Are there divorce costs? What about home repairs?

    Evaluate where you are spending your hard-earned money and use this list as an opportunity to gain insight to your personal spending habits. When you understand your relationship with money, you can make that important move forward.

    Make a Budget

    Some of the key tips to getting out of debt are tracking spending, reducing debt load and embarking on a savings plan. All of that is a lot easier when you work off a monthly budget.

    Drawing up a budget is not nearly as abysmal a task as consumers make it out to be. You can still go out to dinner and a movie or play a round of golf with friends or go to the beach for a weekend. You just have to account for it, and if necessary, cut back in other places.

    The purpose of a budget is to give your money a direction and a purpose. The budget sets spending goals for needs like rent, utilities, groceries and transportation while at the same time, accounting for spending on “wants” like clothes, dining out and entertainment.

    A good budget summarizes your spending at the end of every month and helps you identify areas where money was wasted. You often will be surprised at where you spend the money and how much you spend on items you could easily live without.

    The best budgets are flexible enough to allow you to make changes from one month to the next so that less money is wasted and more money is directed to reducing debt. Creating and sticking to a budget is one of the surest ways to help you get out of debt.

    If you’re not confident in your ability to start a budget, get in touch with a nonprofit credit counseling agency. They all offer free advice on how to start and stick to a budget.

    Track Your Spending

    If you’re not sure how much you spend on daily living expenses, such as groceries, personal items and transportation, set aside receipts for two to four weeks and review them.  If you don’t take the time to track where your money is going and make the needed changes, then you are in danger of repeating the same behavior even after you pay down your current debt.

    Once you have some numbers to work with, calculate your net monthly income and your average spending to include mortgage or rent, insurance costs, health care, education, utilities, any loans and the minimum payments on credit cards. While the numbers may startle you, remind yourself you are taking the first step to making positive and significant change.

    The best way to start tracking spending is to go over bills and simply list every item purchased. Once you have the list, code the items into a category. For example, write “Gro” next to supermarket purchases and “Din” next restaurant bills. Do the same for rent, clothes, utilities and everything else you spend money on. You might market one-time expenses like a home repair as a “Misc” for miscellaneous. After the expenses are divided by type, figure out how much you spent on each category every month.

    The next step is the tough part. Figure out your average monthly expense for each category over the last three or four months and enter the amounts on a list. Once done, add up all the expenses for a total and compare it to your average monthly income. If the outflows are higher than the income, you have a problem that demands adjustments.

    A budget is a model for bringing spending and income in line. Better yet, it contains a plan for paying down debt and possibly saving money for an emergency fund.

    Some amounts can’t be changed easily, like the rent, but others can. Set goals in those categories until you bring your outflows in line with your inflows. If you’re spending $400 a month eating out, but reducing that to $200 would bring you closer to a balanced budget, then making cutting $200 as a goal. Then figure out how many times you can dine out to meet the goal.

    There’s an abundance of software and apps to automate this process. You might consider buying software for your computer or using an online budgeting program and plugging your numbers into that. Either way, it will simplify the budget building process.

    Earn More Money

    There are three routes to a positive cash flow: you can spend less, earn more or do both. Not all cash problems occur because you spend like a proverbial drunken sailor. Sometimes you end up earning less than you did in a prior job and you can no longer keep up with your costs.

    The easiest way to improve your finances is to add to your income, though figuring out how to do that can be a challenge.

    Finding a new job that pays more is one way, but adding a second one works well too. Folks, this might not be easy. Working more hours, or even going through the motions of looking for work when you’re comfortably employed, require discipline and effort. But you can do it.

    Start by asking your boss about overtime opportunities. If they aren’t available and you want to stay where you are, think about skills you have that might make extra income. If you’re an amateur plumber, maybe you could fix leaky pipes in your neighbors’ homes. Or if you waited tables when you were in school, perhaps you could find restaurant work part-time on the weekend. The possibilities are nearly limitless, but you need to create a plan.

    Another short-term fix is selling stuff. If you have an attic or garage filled with unused items, consider a garage sale or selling things individually on Craig’s List. This won’t help your long-term income, but could give you an immediate boost, money that could be used to pay off a credit card balance.

    The goal here is developing an extra-income source that will help you pay down debts, avoid new debts in the future and saving enough for a cushion to cover emergencies and unforeseen setbacks like a job loss.

    Change Debt-Enabling Habits

    People are creatures of habit, and we can develop bad ones all the time. Overeating is a habit. So is smoking or compulsively buying lotto tickets. Sometimes bad habits damage your health, but even more frequently they attack your wallet.

    How do you identify bad spending habits? Often you know already. If you’re tired of going to the same restaurant or clothing store, that means you probably been there too often and spent too much money. Unfortunately, many examples are not as obvious and are best identified by studying your receipts and credit card bills. If your spending exceeds your income, a bad spending habit could easily be the culprit.

    Begin with your receipts. How often do you buy coffee at Starbucks instead of brewing it yourself? Do you have a housekeeper clean your house when you could just as easily do it on Saturday morning? Do you set your air conditioner so low you need to wear a sweater in July? Some of these habits have become so much a part of the way you live that you might not even recognize them as bad habits.

    Next, study your credit card bills and bank statements. Often, you’ll see the patterns of habitual spending. If you put lunch on plastic every day at work, you’ll see a long list of restaurant expenses. Add those up and think about how much you could have saved brown-bagging lunch most of the week.

    Identify your biggest spending areas. Eating out, for instance, or drinks with your friends every Friday. Think about whether you could do these things less frequently, or at least less expensively. And consider the services you pay for that you could yourself, things like mowing your lawn, washing your car, changing the oil in your car.

    Reduce Your Debt Load – Ways to Lower Your Debt

    There are several ways to help reduce the cost of existing expenses to help lighten your debt load from refinancing, consolidation and renegotiating payment terms.  Among them are refinancing your home or car, consolidating your loans or bills and renegotiating your existing loans or payment plans.

    Refinancing

    Refinancing allows you to lower the monthly cost of items that are otherwise tough to change. If you plan on staying in your home long enough to recoup transaction fees, refinancing your mortgage to a lower rate may be an excellent way reduce your monthly obligation.

    Refinancing a car or student loan to a lower rate is also an option, and many lenders may reduce the rate on the student loan if you have a good payment history.

    Consolidation

    If you have built equity in your house, a Debt Consolidation Home Equity Loan or Line of Credit is another option. This approach allows you to replace credit card, auto loan or other high-interest debt with a lower interest rate loan.

    At the beginning of 2017, the interest on home equity loans or lines of credit was 4% to 6%, well below the 16% and more charged on unpaid credit-card balances. Home equity credit lines, called HELOCs, and other home equity loans are also potentially tax-deductible.

    If someone does consolidate loans through a home equity loan or line of credit, it’s important to realize that the new loan is now a secured debt. The house, in effect, backs up the loan, so it is a less-risky venture for the lender.

    While consolidation may lower your monthly obligation, it’s vital to remember your total debt load has not changed, only the way you are paying it off. Continuing to use credit cards and taking on new debt could make your financial situation worse.

    Renegotiating Terms

    Here’s something you may not know: credit card companies will negotiate terms with you. Not always, but they are more flexible than consumers think.

    Sometimes all it takes is a phone call to customer service to lower your credit card rate, whether it’s a fixed or variable. When you call, tell the customer service agent your current interest rate, how long you have been a customer and of any pre-approved balance transfer offers from other banking institutions you may have received in the mail.

    One survey reported 56% of consumers that asked for a rate-reduction, got one and the average savings was more than 30%.

    Snowball vs. Ladder Approach

    If you’re in debt, it’s likely you have more than one creditor. Managing debt is like juggling: the more balls you have in the air, the harder it is to manage them. Credit cards work the same way. If you have only one card and are trying to pay off the balance, it’s easy to focus. But if you have five cards that all have balances, it becomes trickier knowing how to proceed.

    Keeping all the balls in the air – meaning you don’t go into default on any of your credit cards while you pay off what you owe – is best tackled with a strategy. There are two schools of thought in the debt management world for how to do that.

    The first strategy, known as the snowball approach, requires that you list all your debts by size, disregarding interest rates, and paying down the smallest first. The tactic requires that you continue making minimum monthly payments on all but the smallest debt, which you begin to tackle with whatever cash you have available.

    One advantage to the snowball strategy is the short-term psychological reward. You can pay the smallest debt in the shortest amount of time, and it feels great to have checked a creditor off your list. Once the smallest is paid off, move to the next smallest until you eventually are clear of debt.

    The other strategy is called the ladder approach. In this model, you list all your card debt by interest rates and focus repayment on the one with the highest interest rate, regardless of how much you owe on each card. Mathematically, this is the best approach because it saves on interest payments, but it might not be as satisfying because it likely will take longer to pay off your first card.

    It’s important in both cases to pay the minimum monthly balance on all cards while you pay down the one you’re focused on. And as you pay off cards, don’t close them as that will have a negative impact on your credit score. Just put them in a safe place and don’t use them.

    Pay Down Your Credit Cards

    While you may be eager to wipe away all your debt quickly, some bills are best paid off before others. It is recommended you take care of credit card debt prior to paying off car loans or a mortgage because credit card interest rates are typically much higher, and mortgage interest is tax deductible.    

    Many financial analysts recommend consumers begin reducing their debt by paying more than the minimum payment on credit cards/loans with the highest interest rate. Once the high-interest debt is paid, you can tackle the next one more quickly by combining the regular payment along with the money previously paid on the first card.

    For example: if you are paying $300 a month on credit card A and $200 per month on credit card B, once A is paid off, make $500 payments on credit card B. You’ll be surprised how quickly your debt will continue to dissolve.

    Some financial analysts recommend paying off the credit card with the largest balance relative to your credit limit first as that will help improve your “utilization ratio.” This number indicates your borrowing power and accounts for 30% of your credit score.

    While there are multiple theories, find the one that works best for you as they all eventually result in financial freedom.

    While you’re paying down the debt, you should consider not using credit cards at all. Putting expenses on plastic is a tough habit to break. It’s convenient and very fast, but as a debtor you know that the results can be financially devastating.

    Using cash a good alternative. Checks are nearly as good, assuming you have a checking account. The advantages are clear: You can’t spend more cash than you have in your wallet, and using checking accounts properly means no overdraws. Of course, you need to know how much money is in your checking account to avoid bounced-check and fees for overdrawing. Checking accounts aren’t credit accounts, so you need to only spend what you have.

    Moving Forward and Saving

    According to research, 67% of Americans haven’t saved enough to cover six months of expenses. Living on such a short leash can make paying unexpected bills difficult, especially if you’re shackled with a lot of credit card debt.

    But it can be done in most cases. The first step is to understand what you owe. Put all your most recent credit card statements on your dining table and make a list of what you owe on each one. The list should include the name of the creditor, the interest rate and the minimum monthly payment. Then look for the part of the statement that tells you how much you’ll need to pay to pay off the debt within three years. Once you finished with the cards, add any other loans listed on your credit report, which you can obtain for free from any of the nation’s three credit rating agencies.

    Next, compute your debt-to-income ratio, which is your annual earnings versus the total amount you owe, excluding mortgages. Lenders use debt ratios to assess your creditworthiness, and it will give you a good idea where you stand financially. How do you do it? If you make $60,000 a year and owe $30,000, your debt ratio is 50%. Most lenders consider that a poor ratio, making it difficult to get a loan. The ideal debt-to-income ratio is under 35%.

    The goal here is to have a good idea of how your finances line up and what it will take to improve them.

    It’s highly recommended that while you pay off your credit card debt you also make payments to your savings account. Whether you make $20 payments on a weekly basis or $100, you will come out ahead of the game. Perhaps in an emergency situation, you will not have to rely on your credit cards in the future – giving you the debt-free living you desire.

    Of course, while refinancing, consolidating and/or renegotiating terms can put you in a much better financial situation, it’s important to remember to watch your daily spending habits.  Cutting back on expenses will help you in the long-term.

    With a little planning, downsizing your expenses and living within your means can be easier than you think. Simply bringing your own lunch to work five days a week instead of eating out can possibly save $200 per month – thousands of dollars in one year you can use toward credit cards or even put into a savings account. There are so many little ways to save: buy in bulk and freeze foods to make a dent in the grocery bills, skip the automatic car wash, brew your own coffee, mow your own lawn and get rid of your home phone.

    When You Need Advice

    If you need financial advice on how to produce a workable budget and pay down your debt, there are many nonprofit credit counseling organizations that can help. Most of these services are available through the Internet, telephone or in-person at local offices.

    While there are numerous reputable debt counseling agencies that can help you manage your finances and consolidate debt, there are many disreputable agencies, so be sure you investigate their reputation and terms before signing any paperwork.

    According to the Consumer Financial Protection Bureau, there were 39,483 complaints about one report, nearly 17,000 people logged complaints about scams with the Federal Trade Commission (FTC) in 2010.

    Be wary of anyone wanting a fee to modify a mortgage.

    Be wary of counselors who promise to save your home and require money upfront.  These counselors, according to a one large financial institution, are known for telling their customers that payments to them go toward a lawsuit that will bring your mortgage current and drop your payments.

    Don’t transfer your home’s deed. Some companies use this tactic in trying to “save” it. Never make your mortgage payment to anyone other than your mortgage company unless they approved the deal.

    Consider reaching out to a non-profit credit counseling service located at many universities, military bases, credit unions and branches of the U.S. Cooperative Extension Service.

    A big part of getting out of debt is understanding that you can get out. Despite the total debt you have, there are ways to deal with each situation.

    After you acknowledge that this is possible, know that help is available. You don’t have to go through this alone. But the first two steps are the biggest: acknowledging that you need help and being willing to get it.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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