Seven Steps to Get Out of Debt

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After detailing the fact that many Americans are deep in debt, I wanted to list how people can get out of debt. I've counseled scores of people through the years -- some with tens of thousands of dollars in debt -- and have seen these principles help them become debt-free. Here are my bullet-pointed steps/thoughts from an upcoming speech I'm preparing:

Step 1: Stop digging the hole.

• If you want to get out of debt, you have to stop accumulating any more debt.

• Do what it takes to make this happen – cut up your credit cards, freeze them in ice, make credit card cookies, whatever.

• You have to stop the hemorrhaging before you can begin to work on the debt.

Step 2: Develop a budget.

• John Maxwell says, “A budget is telling your money where to go instead of wondering where it went.”

• With a budget, you know where your money is coming from, where it’s going, and you have the ability to control it.

• Put together a budget based on what you have been making and spending.

• You can get a simple budget form from Crown Financial Ministries.

Step 3: Look for ways to improve your cash flow.

• If you want to improve your cash flow, there are only two ways to do it – earn more and spend less. So work to create a big gap between what you make and what you spend – the bigger, the better.

• Have a trusted, successful friend to look over your budget. He or she can suggest ways you can make more and spend less.

• Then you’ll likely need to make some hard choices. I say “likely” because the toughness of the choices will depend on the amount of debt you have as well as the size of your income/expenses gap.

• If you currently have a lot of debt and not much gap, it will be difficult. You may need to cut your cable TV, take vacations around home, etc. You’ll probably have to give up many things you like. You may even need to sell some things. Getting into debt is fun – getting out of debt, not so much. But the freedom is worth it.

Step 4: Get a basic emergency fund.

• As you create your income/expenses gap, save $1,000 so you don’t have to borrow again when emergencies pop up. And they will pop up. Washing machines break, cars need repairs, kids need braces, and so on. It’s a fact of life.

• Here’s one idea: use your tax refund to get started. TurboTax says the average refund is $2,869. That will get your emergency fund established and still leave extra for debt repayment.

Step 5: Begin the debt snowball

• Make a list of your debts in order, from the smallest balance to the largest.

• Include the amounts owed, the dates due, and the minimum or required payments

• Don’t be concerned with interest rates, unless two debts have a similar payoff balance. In that case, list the one with the higher interest rate first.

• Pay minimum payments on all of your debts except for the smallest one. Then, you need to attack that one with what Dave Ramsey calls “gazelle intensity!” In short, this is the intensity a gazelle has when he’s being chased by a cheetah – he’s focused, he’s determined, and he’ll use all his might and wits to succeed.

• In short, every extra dollar you can get your hands on should be thrown at that smallest debt until it is gone.

• It’s worth noting that the math seems to lean more toward paying the highest interest debts first. However most people in debt need some quick wins in order to stay pumped enough to get out of debt completely. Once they start knocking off the easier debts, they start to see results and have the motivation to keep going.

• Once the first debt is paid off, attack the second one. Every time you pay a debt off, you add its old minimum payment to your next debt payments.

• Just as the snowball swallows up more snow as it rolls, your debt will get swallowed up in a financial avalanche.

Step 6: Make the income to expense gap bigger.

• Keep working at increasing income and decreasing expenses.

• Consider selling some of your stuff to get some bigger wins.

• Take the funds freed up and put them against your debt.

• With focused effort, you can work down your debt rather quickly.

Step 7: Max out your emergency fund.

• Once credit card and consumer debts are paid, start saving six months worth of living expenses.

• This is a fully funded emergency fund and should help you survive all but the worst financial emergencies.

• Best of all, it will keep you out of debt in the future.

That’s it! Those are the seven steps to get anyone out of debt. Apply them and you'll ultimately be able to enjoy freeeeeeeeedoooommmmmmmmm from debt!

Comments

[TheDebtHawk.com]

I think that people need to think about earning more money pursuant to step 3 above. The is no better way to pay off debt than to get a second job, or better yet, start a side business. The increased cashflow from a second job can really accelerate your debt payments.

[Kelly]

Sounds like someone has been listening to Dave Ramsey! Not far off.

[Money Reasons]

Great tips on the steps to become debt-free! Now if I could just somehow get rid of my regular day-to-day expenses...

[Budgeting in the Fun Stuff]

Great summarized steps! I'm sending people to this article when they ask about debt repayment...

[Karl]

I would qualify the "start a side business" suggestion with:
- it should be minimal investment in money to get started
- it helps if it's in an area of expertise or hobby (FMF has a lot on this)

I tried to "start a side business," and I had my head in the clouds hoping to be the next big web company and all I did was get more in debt because I didn't follow the above two qualifications.

[Three]

Awesome tips. I've also read Dave Ramsey's advice and sounds a little like this as well. But that doesn't matter great tips nonetheless! What most people i know find hard to do is saving $1000 when they still have debts to pay. But i guess, as an alternative, they can slow start saving for it. With the decline in the economy, saving money is the best thing to do because we'll never know when we'll be out of job. And i've seen a lot of people suffering from debts and having a hard time trying to repair credit rating.

[Mike]

I have started my living debt free 2011 program starting with number 2 & 5 on your list. I have a strict budget that I do not waiver from and I am using all extra money to get rid of my credit card debt once and for all asap.The whole key for meas probably most people is to get rid of any unnecessary credit debt. As soon as I get this debt down everything else will fall into place for me.