If you find yourself in a situation where your mortgage, car payment, personal loan, or credit card is driving you crazy, there can be multiple solutions. And no, it doesn't have to involve driving a $500 rusted-out car and having 4 jobs while you live on hot dogs and Ramen noodles.
I'm speaking to you from a position of someone who has been there and done that with debt. It sucks, it's not fun, it's embarrassing, but it can be fixed.
HOW DOES DEBT AFFECT YOU? BEHIND THE NUMBERS...
Before you take out a mortgage on the big house in the posh neighborhood, or take out a loan to buy the fancy car, or put the new Jordans on your credit card - do a quick Google search.
Find out how much that house, car, or purchase is really going to cost you.
Home:
$400,000 house
$80,000 down payment (20%)
30-year fixed mortgage at 7% interest
Total cost: $846,428 (and that doesn't even count taxes, insurance, repairs, or anything else)
*You're paying over $445,000 to the bank to finance the house
Car:
$40,000 new car
$10,000 down payment or trade-in
5-year loan at 5.75% interest
7% sales tax
Total cost: $57,390.18 (and that doesn't include any registration, title, or other fees)
*You're paying over $4,500 to the bank to finance the car
Credit card purchase:
$1,000 purchase put on credit card
22% interest
You only make minimum payments
Total cost: $2,065.67 (and it will take you NINE YEARS to pay off)
*You're paying over $1,000 to the credit card company to finance your purchase
HOW TO ESCAPE:
The magic genie isn't coming along to grant 3 wishes. The Powerball ticket isn't going to hit. The newest cryptocurrency isn't going to turn you into an overnight millionaire.
Getting out of debt is simple, but that doesn't mean it's easy. Are you ready to tackle this and take the necessary steps to get out of the debt hole? Then let's go!
Step 1: Figure out why/how the debt happened
This could be a very easy step if you've had an unfortunate circumstance like a job loss, health issue, or unexpected home repair. But, if it's a matter of overspending, keeping up with the Joneses, shopping addiction, or being "influenced" by social media, it's time for a tough conversation with the reflection in the mirror, as well as your family.
This is not the time for excuses, this is the time to own it and move forward.
Step 2: Make a vow to stop the behaviors that caused the debt
Behavioral change is, by far, the hardest part of this process. Why bother doing all of this work to pay off your debt when you're just going to do it all over again? If the solution involves therapy or some other form of mental health assistance, don't judge yourself or let anyone else judge you. The idea is to get the job done, and never have to do this job again.
Step 3: Where are you right now?
The idea here is that you need to know your starting point before you can come up with a plan. You need to know about every single dollar coming in, and every single dollar going out. There are a million ways to accomplish this, it's just a matter of what works best for you.
- Pen, paper & receipts
- Spreadsheet
- Software like Rocket Money, Quicken, YNAB or Monarch. These systems link to your bank account/credit card automatically and help you analyze your cash flow in and out
Remember, we aren't fixing anything just yet. We're just trying to get an idea of how much money is coming in, how much money is going out, and where that money is going.
Track EVERYTHING. Every candy bar, every Amazon purchase, every annual bill. You're only cheating yourself if you fudge the numbers.
Step 4: How much is left over?
This step is critical, because it will determine the next steps going forward. In an average month, how much money is left over to put toward your debt?
If you're in a situation where your bills and your spending already exceed your income, you have two options:
1. Find ways to cut down on spending. Analyze every single item on the spending side of your budget and figure out how you can reduce or eliminate it. By the way, skipping your daily Starbucks will not make you a millionaire, but doing so can certainly help you get out of debt faster and cheaper.
2. Find ways to increase your income or your assets. This does NOT involved investing in a "get rick quick" scheme. This can involve selling items around your house that you don't need. Maybe you could take on a part-time job or side gig that you enjoy? What if you downsized your house or cars? There are a million ways to do this, from the simple to the extreme. How serious are you?
If you have leftover money every month, or you've taken steps to provide extra money every month, let's move on to Step 5.
Step 5: Attack, attack, attack.
Here's where the fun begins and you can start to radically transform your life!
I'll give credit to Dave Ramsey here, because he has popularized what I believe to be the best debt payoff method out there: The Debt Snowball Method (more details here)
In a nutshell, this method encourages winning over math. The numbers tell you that you should pay off your highest-interest debt first. Quick example:
Credit card #1: $10,000 owed with a 28% interest rate and a $333 minimum payment
Credit card #2: $7,000 owed with a 22% interest rate and a $200 minimum payment
Credit card #3: $3,000 owed with a 12% interest rate and a $60 minimum payment
*You have determined you have an extra $300 per month to put toward your debt.
(You can examine your own credit card situation here)
Which one should you work on paying off first?
Well, the math says it's obvious. Start chipping away at the $10,000 credit card. It's a big balance, a big payment, and a big interest rate. That would help you breathe so much easier, right?
Not necessarily. Years of research has shown that people are significantly more successful in paying off their debt when they ignore the "correct" math and give themselves successive wins. So what does that mean?
You start by attacking your smallest balance. In this case it would be credit card #3. You only make the minimum payments on credit card #1 and #2, and you put the extra $300 per month toward credit card #3. You'll have card #3 completely paid off and eliminated in less than a year! That's a HUGE win!
OK, so what next?
Here's where the "snowball" comes in. You were paying a total of $360 per month on credit card #3 ($60 minimum payment plus your extra $300). So now you have an extra $360/month to start chipping away at credit card #2. Remember, keep making only the minimum payment on credit card #1.
So now, you're paying $560/month on credit card #2 (the $200 minimum payment plus the extra $360/month). This credit card balance will be GONE in about 15 months. How awesome would that be???
The snowball continues after you've paid off credit card #2 and #3. We are now up to a "snowball payment" of $560 per month extra to put toward credit card #1. Add on the minimum payment you were already making, and this gives you $893/month to knock out that credit card and be DEBT FREE!
The payoff on credit card #3 should be around 14 months. That means you can be completely debt free in just over 3 years!
For comparisons sake, if you just kept making your minimum payments on all of these cards, it's very possible that you would die before you paid them all off.
Step 6: Enjoy your debt-free future
What an awesome accomplishment - you've gone from having sleepless nights to having an extra $900/month! What should you do with that money?
That's where a conversation with a financial professional comes into play. Tell him or her about your situation, your goals, and your amazing success in getting out of debt. He or she will help you to determine a plan for your next steps.
Beware of "financial salespeople" that start pushing a product immediately. Make sure you are working with someone who asks more than they talk. Make sure you're made completely aware of ALL fees and/or term requirements.
Most of all, make sure you're comfortable. If you see a red flag, trust your gut.