Seven Steps to Get Out of Debt

Let's face facts, many Americans are deep in debt.

The general attitude of American consumers has long been "I want it and I want it now." Unfortunately, this line of thinking often doesn't line up with a person's level of income. And so they have to borrow to get what they want when they want it. Then in no time they are up to their eyeballs in debt and in deep trouble financially.

The recent economic issues have put this situation on hold for a bit, but don't be mistaken -- it's only hidden, not dead. This isn't like the depression where it was so bad that people changed their ways of managing money forever. No, I think that Americans will return to their borrowing ways at the first sign of recovery. I could be wrong, but I don't think so.

I have seen the impact of debt firsthand. My wife and I used to counsel couples in debt and were appalled at how much money people can borrow for so many (usually worthless) things.

Anyway, since being in debt is such a big issue for so many people, I thought I'd offer some suggestions. Here are my bullet-pointed steps/thoughts for getting out of debt:

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

[Luis]

I used to think paying off higher interest rate cards a better plan but I've been convinced over time that it is not the way to go for achieving success. And it just dawned on me that it could be possible for a debt payor to inadvertently think he has a high interest debt when actually the majority of the balance was accumulated during a time when the card was at a much lower interest rate.

[Kathy]

My only recommendation to add would be to continue making your retirement account payments. I THINK Dave Ramsey suggests suspending those when paying off debt and that is the only issue I have with his advice. IMO no one should ever suspend retirement payments. Work your debt repayment around the retirement account payments. You can lose too much earning potential is you suspend those payments for very long.

[Angela]

The steps listed above reminded me of a book I read by Steve and Annette Economides who wrote America's Cheapest Family Gets You Right on the Money. Some of their steps are a bit extreme, but they're just describing their frugal lifestyle practices. Both the above and the Economides advice are great resources in general.

[MITM]

Thanks FMF. Nothing new but good old common sense that I'm always grateful to be reminded of.

You and many others are way further along than us, but we currently have $300k in net assets and have a 8.5 year timeline to pay off all debt including a lot of student loans a rental and home mortgage. It's a long slog but we're doing it.

Thanks again for your blog and the encouragement it provides.

[G. Reves]

Wow, sure wish Turbo tax would get me an average $2800 refund. Husband retired, I drive a school bus with loss of aprox. $7,000 in cutbacks, have a house payment,pay high property taxes on a very moderate home plus few other things....and still have to pay about $500 more in taxes. Seem like when you lose the child deductions - look out, they really nail you and it's getting where you can't hardly deduct any thing any more. Welcome to he USSA !

[Karen Kinnane]

Dear G. Reeves, Your husband has retired. What's stopping him from taking a part time job to increase your family's income? He could walk dogs, deliver pizzas (Dave Ramsey's favorite), deliver the weekly shopper newspaper, garden, run errands, clean houses, deliver flowers for the local florist, deliver auto parts of liquor for a local business, work at Wal-Mart or Home Depot a few days a week. Go through your stuff and have husband run a yard sale and apply proceeds to your debts. Retired doesn't mean your husband doesn't have to ever work again. Or sell your house and move to a low tax state like Florida or Texas.

[Devon]

Your post make very good points. I especially like your mention of the emergency fund. There are not many people setting aside money for when emergencies happen. It also should be mentioned that what classifies as emergency. Many people will come up with many ways to spend their emergency fund. Therefore, they should have clear understanding exactly what a emergency is. A good article.