4 Steps to Getting out of Debt for Good
Are you sick and tired of sending payments to creditors every month? Do you want to keep more of your money and not waste it on interest? If this sounds like your situation, then debt freedom is a goal worth pursuing — but it’s not always easy to achieve.
Far too many people make some progress on debt payoff, but then end up right back where they started when things go wrong. Others don’t make much progress toward paying down debt at all, despite their best efforts. If this sounds familiar, you’re probably frustrated with the entire process of dealing with your debt.
The good news is that there are steps you can take to become free of debt for good. In fact, if you do these four things, you can significantly increase the chances you’ll be able to avoid borrowing for the foreseeable future.
1. Make a budget to live within your means
If your expenses exceed your income, you are always going to be in debt because you’ll need to cover the shortfall. The only way to make sure you don’t end up continuing to dig yourself into a hole is to make a budget and use it to ensure that you are living within your means.
Start by tracking spending to see where your money is going, and then make a list of all your sources of income. Next, create a detailed budget, giving every dollar a job. Don’t forget that some of those dollars will need to go toward savings, debt repayment, and accomplishing other financial goals. And leave yourself a little spare cash to budget in for surprise expenses that inevitably come up during the month. Finally, account for irregular expenses, such as holiday spending and annual car inspections so that you can save for them throughout the year without blowing your budget.
If you can’t make a realistic budget that keeps your spending below your income level, you’ll have to increase your income or find a way to make major cuts. Cutting back on dining out or entertainment is not going to make up for a big budget shortfall — you might have to relocate to a cheaper place, downgrade your car, get a roommate, or make another drastic changes to make your budget work.
This step won’t be fun, but you need to do it if you don’t want to rely on debt to cover cash shortfalls going forward. And remember, it’s worth making those sacrifices now to get rid of your debt and free up the cash you currently spend on debt repayments and interest.
2. Commit to not borrowing
Living on a tight budget can be really frustrating, and you may be tempted to splurge. Especially if it feels as if your debt is so high you are only adding a few extra dollars to an insurmountable tab.
Unfortunately, if you blow your budget and have to borrow, this can start the debt cycle all over again — or deepen your existing problems. You have to pay interest on every dollar you borrow, and so you’re committing future income to repaying creditors, which will result in the need for an even tighter budget.
If you don’t want to find yourself back in debt, or deeper in debt, it’s time to completely commit to viewing debt as unacceptable in all circumstances. You can make exceptions, such as a mortgage on a reasonably priced house, a car loan for a safe used car, or student loans to fund an education that will improve your earning power.
But think carefully about the circumstances under which you are willing to borrow and make a firm promise to yourself that you won’t ever again buy anything you can’t afford to pay for.
This doesn’t necessarily mean you have to give up using credit cards. Using a card has many benefits, as cards can help you to earn rewards and build credit. But this does mean committing to never charging more than you can pay off before incurring interest. If you find that you can’t use cards responsibly in this way, you may have to switch to cash — at least temporarily — until you are sure your spending is fully under control.
3. Save up an emergency fund
Even with a careful budget that accounts for some surprise expenses and irregular expenses, it is inevitable that big financial emergencies will crop up.
And if you don’t have the money to pay them, this can derail your best efforts to get out of debt and stay there. This is especially true because there are times when it is simply not optional to spend money to deal with an emergency — such as when you have a surprise medical expense that you’ll have to take care of right away.
You can make sure emergencies don’t send you back into debt by saving up an emergency fund. Start with a small emergency fund as you work on debt paydown. This may mean saving up just a few hundred or a few thousand dollars depending on your income and typical expenses in your household. But you need to have some type of emergency fund in place before you start making extra payments on your debt so that you can break the borrowing cycle.
As soon as you’ve paid down your consumer debt, it’s time to build a bigger emergency fund. Your emergency fund should eventually have three to six months of living expenses in it. This will ensure you don’t have to borrow even in major emergencies, such as an extended job loss or a serious medical crisis.
4. Aggressively pay down your debt
You need to get rid of any current consumer debt you owe, and you’ll want to do this ASAP by making extra payments to creditors.
It usually makes little financial sense to pay off your mortgage debt and student loans early because these debts can come with tax-deductible interest and very low interest rates. In the case of federal student loans, there are also income-based payment plans, options for loan forgiveness, and other important borrower protections.
Other debts, though, cost much more than you can earn if you invest your cash — and they provide no tax benefits or other advantages. These debts, such as credit card debts, payday loans, and medical loans, should be paid off as soon as possible.
Make a plan to pay extra toward one particular debt — either the one with the highest interest rate or the one with the lowest balance — and send as much extra money as you can to this creditor while continuing to make minimum payments on all debt. Once you’ve paid that debt down, start sending all the extra cash you have to the next debt on your list. And if you get a cash windfall such as a tax refund, send that money to your creditors as well. The more extra money you can send, the sooner you’ll finally be free of your debt burden.
Staying debt-free isn’t easy, but it’s doable
Taking all four of these steps isn’t easy — but it is within your reach. If you are serious about not borrowing anymore and are willing to make the necessary sacrifices, you’ll be surprised at how successful you can be at paying off debt and not getting back into it.
This content was produced by The Ascent, a personal finance brand by The Motley Fool.
