There are several things you can do to eliminate debt entirely, or at least pay off most of it, when becoming debt-free is a priority.
Being in debt can be a stressful experience regardless of your circumstances or the amount you owe.
You may sometimes have an urgent need to reduce your debt levels if you have a life-altering experience like losing a job, getting into an accident, or even if you have a sudden increase in monthly expenses following the birth of a child.
Here are 7 steps to take to reduce your debt levels today which are sure to work.
Step 1: Take Stock of Your Situation
Before you even begin budgeting or start thinking of a snowball vs. debt avalanche method, it is important that you take stock of your situation. You need to know exactly how much you owe and to whom.
It is best to create an excel sheet or use one of the debt calculator apps to keep a tab of kind of debt (loans, credit card), interest rates (lowest to highest), and amount due.
A lot of people make the mistake of assuming their debt is a certain figure, like $8,000 when in reality it is touching $10,000.
You will never hit your target to reduce the debt if you don’t know how much it is. Be brutally honest with yourself so that you can create a game plan that will actually work.
It is a good idea to create a list of your income and expenses as well while you are calculating your total debt. Most expenses would already be listed on your credit cards and you can take account of the cash expenses through money withdrawn from your bank statements.
This will give you a real picture of the amount you can actually spare towards paying off your debt.
Step 2: Put a Stopper on More Debt
You need to stop creating more debt if you plan to reduce it. You will never be able to get out of debt if you continue using it to fund your lifestyle. For instance, you cannot keep charging your other credit cards while trying to pay one off.
Start using cash as your primary means of payment. This will prevent you from paying unnecessary interest charges on your credit cards and even save you from spending on some frivolous expenses. After all, stuck with credit card debt is a pain, but you can find ways to get rid of it from Ratebuddy.
A study by MIT in 2000 revealed that people are more likely to pay twice as much for something they want when paying by plastic as compared to cold hard cash.
The researchers dangled scarce Boston Celtic tickets in front of two groups of students, where one group was required to pay cash and the other was asked to pay by credit card. The group paying by cash spent 50% less as compared to the plastic group.
You need to make a conscious decision to stop borrowing money and say no to financing furniture, signing up for credit cards, or test driving brand new cars that you don’t have the cash to pay for.
This will allow you to focus solely on your existing debt and create a strategy to reduce it.
Step 3: Limit Your Expenses
The reason you are in debt is because you spent more than you earned. So, if you are not getting another full-time job, then it may be a good idea to cut down your expenses.
Remember, this is only for a short while and you would be able to take-out from your favorite restaurant fairly quickly, depending upon how much you can save.
The more you put toward your debt, the faster you can reduce it for good. A budget is a great way to cut down your expenses.
Start noting every expense you make. There are many helpful apps to do this. This will give you an idea where your money is going and how to stop the drain.
When setting a budget, make sure it is realistic and something you can stick to. There is no point wasting precious hours, coming up with a budget you cannot adhere to. While you are drawing up a budget, make sure you have enough ‘surplus’ left to pay off your debts.
Limit all unnecessary expenses and reduce luxuries, such as cable, Netflix (you can watch House of Cards, for instance, on your computer via the net), cell phone bills, and others.
Step 4: Create a Strategy
It will take the longest time to get out of debt if you are only paying the minimum on them. You will probably have paid double or even triple what you were originally charged by the time you finally pay off your balance with minimum payments. This is more applicable towards credit card debts.
The only time it’s ok to make minimum payments is when you have a debt strategy in place, such as the snowball approach or laddering.
In this you pay off the smallest debt first while keeping all else current. There are two merits to paying off the smallest debt.
First, you gain motivation and momentum when you see your debt reduce. It is very satisfying, both mentally and emotionally, to have a credit card paid up or a small loan taken care of.
Secondly, by paying off one of the debt instruments, credit card or a small loan, you get rid of the added interest. Even the smallest of debt balances has a minimum interest charge.
Snowball works when you are just starting out with reducing your debt and are not sure how to go about it. By wiping out a few small debts you get tangible progress to get started.
Laddering or debt avalanche is organizing your debt with the highest interest rate first. Remember, you are not concerned about the interest amount, but the rate.
You want to get rid of those debts first that have the highest interest rate, while still paying the minimums on others.
This method is mathematically sensible because you will save the most money in interest over time.
The key to reducing your debt is to stick with the strategy you decide to opt for.
Step 5: Contribute to Emergency Fund
Building an emergency fund may sound counterintuitive since you could better use that money towards paying off your debt balance, rather than stashing it away in a savings account. However, an emergency fund is vital to prevent additional debt.
Life is full of surprises which lean more towards making unwarranted expenses, such as repairing your car, fixing a leaky roof, or making a dreaded trip to the dentist.
Your emergency fund can act as a safety net you can use instead of a credit card or a loan when you need to pay for these things.
Most people rely on credit cards as the go-to source for emergencies. To better manage your expenses and debt, it is important to be mature about your savings.
While the ideal emergency fund is six to twelve months of living expenses, you could start by building up at least $1,000 in the short-term.
You should save as much as possible sensibly or else you may end up racking more debt. Make sure you don’t take a hit on your debt payments.
You may consider taking up side jobs as a freelancer or working double shifts if you are unable to keep up with expenses.
Step 6: Consolidation Loan
Consolidating your entire consumer debt into one loan with one payment at a lower interest rate can be a helpful step in getting your debt paid off. See if your bank or credit union can help you with this.
However, you need to make sure you prevent building up new debt while you are paying off the consolidation loan and save some money every month in an emergency fund.
Even if you manage to consolidate all your debt under a single payment plan, keep making efforts to pay as much as possible. Don’t become complacent and pay just the minimum balance.
The idea here is to take chunks off the principal amount so that you have to pay less interest and lower your debt quicker.
Step 7: Track Your Progress
Keep an eye on your spending by revisiting your progress every few months. At the same time, don’t increase your stress levels by spending each day fretting over your bills.
Get other people in your household involved in your debt management strategy so that you have the support of your entire family to tackle your expenses.
Motivation and support goes a long way in being disciplined and sticking to your budget, especially if you are the primary earning member of your household.
If not, find a community to swap stories, successes, and challenges or a forum where you can feel supported. Debt is a nationwide problem (cities like Chicago, Oakland, and NYC are an example – it’s not just people) and you will be surprised at the number of people riding the same boat as you.
Always remember that saving up to pay off debts is just for a short while. Keep your eyes on the end goal of financial freedom where your money is yours again. Be careful and spend judiciously to prevent yourself from landing in the same position again.