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In the United States, household debt — including student loans, mortgages, credit cards and auto loans — has reached a record of $14.15 trillion in the fourth quarter of 2019. In this how to get out of debt fast guide, we'll talk about why it is important to get rid of debt and have a look at some tips that actually work.
The number is alarming and there is a need to move in a different direction. Debt can destroy your financial standing and prevent you from enjoying your life to the fullest. It doesn't really matter if you have a low income or bad credit, there is always a plan you can implement to get out of debt.
Why it is Important to Get Out of Debt?
The average citizen in the United States owes around $38,000 in personal debt, excluding home mortgages. One of the biggest pieces of this debt, about 25%, goes towards credit cards. This is a concerning figure as unplanned debt can pile up drastically and leave a person broke.
Besides all the financial consequences, when you don’t pay your debt on a timely basis, it can lead to depression, stress, anxiety and poor health. Paying off debt can make your life better overall.
Some of the most common benefits of getting rid of your debt include:
- Boost your financial security: Debt has a direct effect on how you make the most of your money. Think about it, instead of paying interest on your debt, you could be making contributions to your emergency fund with that money.
- Disposable Income: Debt leaves you with less money every month to spend on the things you want. Paying off debt frees up money so you can use it in the things you enjoy in life.
- Credit score: Too much debt can lead to bad credit scores, specially when it comes to credit card debt.
- Own your assets: When you own your car, house, clothes, etc., you don't have to worry about a lender coming after your assets in case you don't make your monthly debt payments.
It's paramount you understand why paying off debt is important. A lot of plans to get out of debt fail because there is no real motivation behind it. If you want to stay on track, you must continuously remind yourself of the reasons why you want to get out of debt.
Step 1: Know How Much You Owe
This is really the first step to get out of debt. You can't develop a plan to get rid of your debt without knowing how much money you owe. Right?
Let’s consider a simple scenario here. Imagine you are saving money on a monthly basis to take your family on a vacation. The simple approach to achieve your goal would be to determine the total cost required for the trip. Then, you would save a certain amount of money every month for a few years until you reach the amount of money required for your vacation.
Debt is almost the same. It's important to first know how much you owe in order to pay it. You won’t be able to devise an effective debt-paying plan until you know the exact amount of money you owe to your creditors. How else would you determine a monthly payment schedule to pay off your debt to the last penny?
There are various ways to find out the amount of debt you owe. Let’s discuss the easiest and most reliable ones.
- Credit Report: Most creditors report debts to the credit bureaus. Your credit report holds information regarding loans, cards, bank accounts, and credit you have taken from somebody. You can use this information to calculate your total debt.
- Emails And Letters: Your creditors — be it a person or an organization — would send you regular emails and letters regarding the money owed. You can use this information to calculate how much money you actually owe.
- Contact Your Creditors: It might be a good idea to get in touch with your creditors to be clear about the amount of money you owe.
- Check Bank Account Statements: Contact your bank to help you out with old statements. It would give you an idea of how much you owe.
At the end, add up the total debt and you’ll know the exact amount you owe.
Tip: It’s best to create a ledger or file and keep a record of the amount of money you owe as it occurs. This will save you a lot of time and effort.
Step 2: Choose a Debt Payment Method
Many of us have more than one debt which can make it difficult to decide which one to pay off first. Psychology suggests getting rid of the smallest debt first, however, you may also choose to clear the highest-interest rate debt first. Each approach has its pros and cons.
Debt Snowball Method — Smallest Debt First
This debt-payment strategy involves getting rid of the smallest balances first, regardless of the interest rate. Doing so will help you manage deadlines in a good manner. This method is usually applied to revolving credit like credit cards.
Here’s the process:
- Prepare a list of all your debts and put them in order (lowest to highest, regardless of interest rate).
- Pay minimum payments on all your debt, except the smallest one.
- Pay as much as you can to get rid of the smallest debt.
- Move to the next debt on the list after getting rid of the smallest debt, and keep doing so until you’re debt-free.
- Has a positive psychological effect.
- A tested method for paying off debt.
- It's simple as it doesn't involve complex calculations.
- Not the fastest way to pay off debt.
- You could end up paying more in interest.
Debt Avalanche Method — Most Expensive Debt First
This method is focused on paying high-interest debt first while paying off the minimum balances on the rest of your loans. This method will help pay off your debt quickly as the main objective is to stop piling up more debt.
Here’s the process:
- Prepare a list of all your debts and put them in order (highest to lowest in terms of interest rate).
- Pay as much as you can to get rid of the most expensive debt after paying the minimum balances on your other loans.
- Move to the next debt on the list after getting rid of the most expensive debt
- Keep working your way down the list until you’re debt-free.
- You will end up paying less interest.
- You’ll go debt-free quickly.
- It can be difficult to stay motivated.
Assess Which Debt You Need to Pay Off First
There is no one size fits all when it comes to choosing the best method for paying off debt. However, here are some examples that may help you decide what's best for you. Let’s say you have 5 loans:
- $800 at 10%
- $1,000 at 12%
- $700 at 9%
- $300 at 3%
Debt Avalanche: You'll make minimum payments on all loans except the $1,000 balance since it's the most expensive one (in terms of interest). Then, you will spend all the money that is left on getting rid of the $1,000 loan. Once done, you'll move to the next most expensive debt that is $800 at 10%.
Debt Snowball: You'll make minimum payments on all loans except the $300 balance since it's the smallest one. Then, you will spend all the money that is left on getting rid of the $300 loan. Once done, you'll move to the next smallest debt that is $700 at 9%.
Which Is The Right Option: If you are disciplined then go for the debt avalanche method, as mathematically speaking, it will save you money in the long term but can be hard to stick to. On the other hand, if you lack discipline and one to achieve quick wins, then go for the snowball method since it offers more motivation despite the fact that it will cost you more in the long run.
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Step 3: Create a Realistic Budget
It’s important to make a budget you can actually stick to. This realistic budget will help you get rid of your debt as it will tell you how much money is coming into your bank accounts and how much money is coming out.
There are a number of budgeting methods out there, however, if you don't know where to start, you should stick to the 50/30/20 budgeting method. In a nutshell, this is how you allocate your money using this budgeting method.
- 50% Needs: 50% of your income should go in essential expenses such as rent, electricity, groceries, utilities, transport, insurance, life cover, and medical aid.
- 30% Wants: 30% should be spent on your wants, that is, your lifestyle. It covers membership fees, night outs, etc. If possible, try to reduce this category and use more money to save or get rid of the debt that you owe.
- 20% Savings: 20% of your income should be allocated for debt repayments and savings. You need to be clever about how much to save and how much to spend.
Remember that the percentages on these categories are not set in stone, you may adjust them to suit your lifestyle and financial goals. This formula will help you track expenses and stay on the right path to pay off your debt.
Allocating 20% of your income towards savings and debt payments may not be enough to get rid of your debt. It really depends on your lifestyle, so make sure you evaluate your repayment plan and make adjustments to your categories so you can pay off your debt faster.
If you find that you need to cut expenses to increase the amount of money you put towards paying off debt, then try to minimize the percentage of your income that goes to the wants category. It’s better not to touch the necessities category (50%). But, you can delay the holiday you have been planning or reduce your night out trips.
Such small changes can make a big impact in your financial life.
Step 4: Update Your Lifestyle
If the amount of debt you have is taking forever to pay, then you need to up your game a notch or two. But, how can you do that? It requires sacrifice and some lifestyle changes.
Start by replacing your car with a cheaper one or moving to a house that costs you less in terms of rent and maintenance. The money you save with these lifestyle changes can be used to pay down debt.
These, however, are major lifestyle changes. You must think carefully before you take such drastic measures as they will have a direct impact on not only you but perhaps on your family members as well.
Here are some ideas on a few basic lifestyle changes you can make today to help you pay off debt faster.
Pay More Than the Minimum Amount (Debt)
If you have extra money in your hand, then use it wisely to pay down your debt as quickly as possible. You can use any of the two debt payment methods explained above. Doing so will allow you to get rid of your debt quickly.
Cut Unnecessary Expenses and Habits
It’s important to save money and the best way to do so is by reducing expenses. However, most people struggle to differentiate between necessary and unnecessary expenses.
If you can’t do without something then it’s necessary, if you can do without it then it’s unnecessary. Food, for example, is a necessity but dining out is not.
Apps like Trim can help you identify and cancel unused subscriptions. Why pay for that gym membership if you never there? Just ask Trim to cancel it for you.
Sell Unused Stuff
If you have items lying around that are of no value to you, then hold a garage sale or put them up for sale online. Apps like Decluttr can help you achieve just that. It can bring you a decent amount of money that you can use to make extra debt payments.
It may also be a good idea to change your lifestyle and get rid of things that cost you a lot of money. Do you really need those Gucci shoes? Probably not, get rid of them and make a few bucks.
Improve Your Spending Habits
Know where and when to spend money. As difficult as it may sound, you may have to rethink your hobbies. Opt for cheaper alternatives. For example, choose a cheaper gym and play a more affordable sport.
There are apps like Qapital that make “saving and spending” fun while keeping you accountable by using rule-based triggers.
Get a Cheaper Car
Most people spend about $120 per month on running and maintaining a vehicle (not including the cost of a lease or loans). The amount can be higher if a car is older. Consider opting for a cheaper option. Some very expensive cars offer poor mileage and can turn out to be very costly in the long-run. Hence, choose a car that’s fuel-efficient and easy to maintain.
Halt Credit Card Transactions
It’s not wise to use your credit card when you already have a massive debt to pay off. Lock away your credit card and do not use it until your debt is paid.
Use cash instead to deal with your expenses. You can even use the envelope budgeting method to ensure you do not end up spending more than needed. You can also use a wallet instead of the envelope. You only carry the money you need, which prevents you from spending more. It can be quite effective in controlling your budget.
Negotiate Bills and Subscriptions
If you have subscribed to a bunch of services such as streaming services, gym, magazines then first consider canceling services that you do not need and next consider negotiating bills and subscriptions.
Some professional companies and service providers such as Truebill and Billshark can help you manage bills and negotiate a lower amount for your bills. Plus, companies are often willing to reduce subscription fees, especially if you sign up for 12 months or more.
Step 5: Try to Renegotiate The Deal
You may have the option to renegotiate your loan and make some changes to the terms and conditions including the interest rate and time you have to clear the debt. Some of the options include:
Refinance or Consolidate Your Debt
First of all, let's be clear that consolidation and refinancing are not the same. Consolidation refers to combining multiple loans into a single loan. On the other hand, refinancing refers to replacing one or multiple loans with a new loan that's easier and often cheaper to pay. In other words, more favourable terms and conditions.
Refinancing can be a good option, especially when it comes to student loans as you may be eligible for a better interest rate and shorter term. Consider this option if you have good credit, decent income, and a graduate degree. Companies like SoFi simplify the process of refinancing a student loan and can help you save thousands.
On the other hand, consolidation can be a suitable choice if you can manage to get a cheaper deal.
Consider a Balance Transfer
A balance transfer refers to the transfer of balance from one account to another. A balance transfer can be quite beneficial when it comes to credit cards since some credit card companies offer special rates including 0% interest balance transfers.
This can prevent you from having to carry the burden. But, remember that this special rate usually only applies to the first year and you may have to pay a transfer fee, which is about 3%.
Balancer transfer can also be used for other debts such as car loans, home loans, medical bills, and student loans. The type and amount of balances one can transfer depends on a number of factors including credit score and the type of loan.
Step 6: Increase Your Income
If you are struggling to pay off your debt because then you need to increase your income. Here are some tips:
Ask For a Raise
You will never get it if you don't ask for it. If you’ve been working for a company for a good few years and haven’t gotten a raise, then discuss the situation with your supervisor. While it may not always work, letting your company know you’re unhappy with your paycheck may push them to consider a raise. Before you ask or a raise, make sure you prepare a list of the things you have accomplished in order to highlight your value to the company.
Earn More With a Side Hustle
If the income from your job is not enough to pay your bills, then consider opting for a side hustle to supplement your income and accelerate the amount of money you can contribute to paying off debt. There are a number of ways to make extra money either online or offline.
Get a Seasonal Part-Time Job
If you have a 9 to 5 job, then you can try a part-time job for a few months. A few extra dollars can make a huge difference in how fast you can pay off your debt. Some good options include deliver food as an Instacart shopper, working as a freelance writer, or even working at your local library over the weekends. There are endless part-time job opportunities.
A part-time job can often make a positive impact financially, but make sure you take care of your health as working a lot or not getting enough rest can take a toll on your health.
Step 7: Stay Accountable and Debt Free
It's very important to set financial goals and to live within your means. You should always stay away from getting into debt, especially credit card debt as this is the most dangerous type of debt.
Here are a few tips to help you stay accountable and debt free:
- Calculate your net income and expenses.
- Create a realistic budget.
- Start an emergency fund.
- Allocate enough money towards paying off your debt.
- Reduce expenses by living within your means.
- Take steps to boost your income.
- Use your extra income to accelerate your debt repayment.
- Avoid new debt at all costs.
Seek help from your spouse or family member to keep you accountable and on track. If you stick to these points, you will steer clear of debt.
The best way to get out of debt is to avoid debt in the first place. However, that may not be practical or possible for that matter as debt is someone essential in today’s world. Your best bet is to create a budget according to your income, lifestyle and financial goals.
If you don't make enough money, then work on finding a good side hustle that can supplement your income and help you accelerate your debt repayment plan. Lastly, control your expenses and save money for the rainy days.
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