Reducing Debt

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A Step-by-Step Guide to Getting Out of Debt

Being in debt feels terrible. Debt will keep you from reaching your financial goals, like saving for retirement or buying a home. It can be a source of stress and grief, causing you to constantly worry about your finances and regret the limits debt has placed on your life. Fortunately, debt isn't a life sentence. You can — and should — make getting out of debt a priority.

Many people struggle with getting out of debt because they're not sure where to start.

People have dozens of questions about the process. Which debts should be paid off first? How much should you pay each month to get out of debt? Is the minimum payment enough? How long will it take? Will it be hard? What will you have to give up? Following these seven steps will give you the direction you need to pay off your debt for good.

1. Reflect on How You Got Into Debt

Traditional advice tells you not to dwell on the past, but in this case, looking back can be beneficial. Getting out of debt — and staying out — requires that you change the habits or circumstances that led you to debt in the first place.

Take some time to think about how you got into debt. Write down three to five factors you believe contributed to your debt. What could have done differently? What will you do differently to avoid debt in the future.

Your Debt May Not Be Your Fault. Often, people wind up in debt because they overindulged and overborrowed. However, this isn’t the case for everyone. Many people have medical debt stemming from uncovered medical procedures.

You may have debt due to divorce.

It's actually pretty easy to get into debt. Credit card companies are ready to give out credit. That is, until you completely destroy your credit. Personal finance isn't taught in many schools. We aren't born with a knowledge of debt or the ability to gauge how much debt is too much. And we're encouraged to finance an education with the hopes of improving our long-term earning potential.

Reflecting on the things that led you into debt isn't meant to make you feel bad about being in debt. Instead, the goal is to recognize what led to your debt so you can take steps to prevent the same thing from happening again.

And if you have children, or will have them someday, these are valuable lessons to pass along so they, too, can avoid debt.

2. Change Your Bad Spending Habits

Coming to terms with bad spending habits is tough. However you've been spending money, you probably have (what feels like) a good reason for spending it. But, if your spending habits are ruining your financial future, you must get rid of them. Stop spending too much money, create a budget, and start an emergency fund.

Identify Bad Spending Habits. Bring your spending into control by tracking all your expenses for at least a month. Then, put your expenses into categories and total up each category. This lets you know exactly where your money is going.

Another way to gauge your current spending is to see the percentage of your spending that goes toward each spending category: housing expenses, gas, food, etc. To calculate a percentage, divide the amount you've spent in each category amount by your total monthly spending.

Once you’ve analyzed your spending it’s time to make changes to where your money goes.

If it seems like you’re spending an abnormal amount of money in any category, look for ways to cut back on that expense. For example, if more than 25 percent of your income is going toward food, you should figure out how you can reduce your food costs. The 50/30/20 Rule of Budgeting can help you keep your spending in check.

3. Figure Out How Much Debt You Have

Up until now, you’ve probably remained oblivious to how much debt you really have. Now’s the time to face the reality of your debt. Make a list of all your debts, the amount you owe, the interest rate, and the minimum payment. Use recent billing statements, canceled checks or bank statements, and your credit report to get a complete list of everyone you owe and the amount you owe.

4. Decide How Much You Can Afford to Pay

If you’re currently paying the minimum every month, it will take you several years, maybe even decades to finally pay off your debt. To pay off your debt much faster, you’ll have to send more than the minimum payment to at least one of your accounts each month.

Use Your Budget to Help Payoff Your Debt. Use your monthly budget to help you figure out what you're able to spend on debt each month. Total your income from all reliable sources including wages, alimony, child support payments, bonuses, or dividends. Then, subtract what you spend each month on required expenses, those items you need for survival. Required expenses include mortgage or rent, utilities, food, transportation, medical expenses, and your current debt (minimum) payments.

Don't forget to account for any irregular or periodic expenses that may pop up during the month. What's leftover after you've covered all your necessary expenses is the amount you can spend on your debt. Use this amount in your debt plan.

Pay Extra Whenever You Can. The more money you can put toward your debt, the faster you can have it paid off. Get creative in how you come up with the extra money by reducing your current expenses and by looking for ways to increase your income.

5. Put Together a Plan

debt plan doesn’t have to be complex.

All you really need to do is prioritize your debts, either by interest rate or by the balance or some other criteria that you choose.

Which Debt Should You Pay Off First? You should choose the method that will keep you motivated to pay off your debts. If optimizing your payments is most important, then the high-interest method is best. On the other hand, if you might become unmotivated by paying on a large debt for a long period of time, then the smallest debt method will be better for you. There may be one creditor you want to get rid of completely. In that case, pay off that credit card first. The goal is to order your credit cards and start paying them off.

How Much Should You Pay? Once you've prioritized your debts, decide how much you’re going to pay every month. It’s typically best to make a lump-sum payment to one of your debts while paying the minimum on all the other accounts. Then, once you’ve paid off one debt, redirect your lump-sum payment to the next debt on your list.

How Long Will It Take? You can see your plan will play out and estimate the time it will take you to become debt free by using a debt repayment calculator. Some let you enter a specific monthly payment or a debt-free deadline to customize your repayment plan.

Note that your debt repayment time may fluctuate depending on the amount you're paying toward your debt and whether you create additional debt. Revisit the debt repayment calculator once or twice a year to see how you're progressing toward your debt free timeline.

6. Start Making Payments

With a plan and a monthly payment amount, what you have to do next is send your payments faithfully every month. This part of the plan will take the longest, several years depending on the amount of debt you have and the payments you make. Consistency with your payments is a necessary part of getting out of debt.

Track Your Progress. Creating debt milestones may help you stay motivated in paying off your debt. By celebrating the small successes, like paying off 10 percent or 25 percent of your debt, you realize the progress you’re making and stay motivated.

7. Don't Create More Debt

You can't use your credit cards if you want to get out of debt. Creating debt while you're trying to pay off debt will only hurt your progress. It's like taking two steps forward and three steps backward. You're only setting yourself back.

It's not necessary to close your credit card accounts, unless you think you won't be able to resist the temptation to use them.

You can also freeze your credit cards to prevent yourself from using them. Yes, literally, place your credit cards in a bowl of water and put them in the freezer. If you get desperate for your credit cards, you'll have to put in a lot of effort to get them out of the ice. Hopefully, that will give you time to rethink using your cards and put them back in the freezer until you're out of debt.

8. Bounceback From Setbacks

It may not be smooth sailing on your path to debt freedom. For example, a financial emergency that requires you to cut back on your increased payment for a few months. That’s ok. Just pick back up with your payments as quickly as possible. You may get discouraged in paying off your debt, and that’s natural. Overcome discouragement and keep your debt repayment on track.

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