Navigating the world of loans, credit cards, and bills can be overwhelming, especially if you find yourself mired in debt. But it’s never too late to go debt-free! With thoughtful planning and honest commitment, you can eliminate your debt this year.
Step #1: Review Your Finances
Most of us have a rough idea of our income, our expenses, and our debts, but eliminating debt requires more exact accounting. Start by making a list of all your income sources, with your pre-tax and take-home pay. Next, record all your fixed expenses like rent/mortgage, cell phone bill, utilities, and contributions to savings or retirement. Subtract your fixed expenses from your take-home pay to determine your discretionary income, that is, the money that you get to choose how to spend each month.
Your next step is to record all your debts. Be brutally honest with yourself. Write down each and every debt you owe, along with the interest rate, the monthly due date and minimum payment. Tally up your debts and your total monthly obligation. Once you know how much money comes in and goes out, you can create a realistic debt elimination plan.
Step #2: Reduce Your Monthly Expenditures.
As you look over your list of monthly expenses, you may realize that you could eliminate some of them entirely. Are you still paying for a gym membership you never use? Could you do without those premium cable channels? Be realistic about your lifestyle, but then identify at least three ways to reduce your monthly expenditure on non-essential items.
Not all of your savings need to come from personal sacrifices, however. You may also be able to reduce your monthly expenses simply by asking. If your account is in good standing, call the credit card company and ask for a lower interest rate. You can also call your insurance company, cable company, and cell phone provider to ask for lower rates. For medical debts, call the hospital or practice and negotiate to pay less if the obligation presents a financial hardship.
Step #3: Decide Which Debt to Eliminate First.
Look over your list of debts and identify the most pressing. For example, if you’ve fallen behind on your mortgage, that could result in losing your home. You’ll need to make that debt a priority. Highlight that debt on your list, and commit to putting all your extra money toward bringing yourself into good standing with that creditor.
Meanwhile, how do you decide what to do about the rest of your debts? Experts recommend that you choose one of these methods:
- Pay the smallest debt first. Studies show that experiencing a “quick win” makes you more likely to win your battle against debt, even if that win is a small victory. So you may want to focus on paying off your smallest debt first. Make the minimum payments due to every creditor, and put any extra money toward this small debt. When that’s paid off, you immediately move to the next smallest debt. Again, pay the minimum to all the others, and use all your extra income for that second debt. Each time you pay off one debt, you’ll have more money to put toward the next one.
- Pay the debt with the highest interest rate first. If you’re making minimum payments, you’re racking up extra debt each month in the form of interest. Paying off the debt with the highest interest rate first will save you money in the long run. Make the minimum payment on all your debts, but put all your extra money toward the debt with the highest interest rate. Once you’ve paid that off, move on to the debt with the next highest interest rate.
Regardless of which approach you choose, it’s important that you keep making minimum payments on every one of your debts. That way you don’t lose even more money to late fees and inflated interest rates.
Step #4: Plan Your Payments.
Missed payments cost you money. Not only will you incur late fees, but you may also end up paying higher interest rates when your accounts fall out of good standing. Missed payments can also hurt your credit score, so you pay higher rates on future loans and lines of credit. The easiest way to avoid late and missed payments is to set a schedule and stick to it.
- Use online bill pay through your bank or through your creditors to schedule payments. Then you don’t have to worry about mailing a check each month.
- If online bill pay isn’t an option, create a calendar of due dates and hang it in a place where you’ll see it every day. Every Sunday, prepare the payments for the week.
- Schedule payments at least a week before their due date. If there’s a glitch or you encounter a financial snafu, you’ll have time to fix it before the bill is due.
- Rather than making one large payment each month, make smaller payments when you get paid every other week.
Step #5: Maximize Your Income.
If you receive a sizeable tax return each year, you may be withholding too much from your pay. Consult an accountant to see if you can reduce your income tax withholdings. You may also want to review your medical insurance coverage and any other coverage that comes directly out of your paycheck. Depending on the amount you have in savings, you might want to increase your deductible to decrease your monthly premium.
And maybe you’re not going to waltz into your boss’s office and ask for a raise, but that doesn’t mean you can’t increase your base pay. If your schedule permits, pick up extra shifts or a weekend job. Consider alternative sources of income, like selling belongings you don’t use or consigning clothes you no longer wear. Dedicate all your extra income to paying off your loans.
Step #6: Avoid Assuming More Debt.
Digging yourself out of debt will be even more difficult if you continue using credit cards or taking out more loans. Cancelling the cards altogether can hurt your credit score by lowering your debt-to-available-credit ratio. Instead, put the cards in a place where you can still access them in case of financial emergency. Exhaust your other financial options before you use credit.
To empower yourself to stop using credit, build up your savings. It’s tempting to skip paying yourself when you’re fending off creditors. Yet your savings will provide a much-needed cushion when you face unexpected expenses. Ideally, you’ll set aside at least three months’ expenses. If you’re not there yet, revisit your budget. Each paycheck, put some money into savings. That amount could be small at first; even putting $10 per paycheck into a savings account will help you build a habit of saving. Then as you pay off more debts, gradually increase your savings.