Let’s face it, living with debt is a huge burden. It controls nearly everything that you do and living with it can feel overwhelming. Debt causes you unnecessary grief and emotional pain. It makes it difficult to change jobs or go out on your own to start a new business. Debt even makes moving into a new home difficult. If you are really masochistic, debt can even make you want to incur more debt – disguising itself as a cure to make you feel better about the debt you’ve already accrued.
While incurring debt may seem like a good idea at the time, the truth is that debt is dumb. The power of debt is that it keeps you working as a slave to the banks. Yet, breaking free from the chains of debt can seem like such a daunting task. Trust me, I know how you feel because I am in debt too. However, I’ve learned the error in my ways and plan to do something about it. You can too! All it takes is a little perseverance and a little know how.
Needs vs. Wants
Before we get into the nitty-gritty of how to become debt free, we first need to have a discussion about which things constitute a “need” and which things are merely “wants”. Simply put, needs are things that you need to stay alive. For our purposes, your only real needs are food, shelter, utilities, and medical expenses. That is it. Everything else is a want. Buying new clothing is a want. Paying for cable tv is a want. Your $200/month data plan for your cell phone is a want. While we are at it, your cell phone itself is also a want. As you begin to pay off your debt, you should be paying for NEEDS ONLY. Paying for wants is only going to set you further behind.
Now, I’m not so naive to think that everybody is going to go out and cancel your cable just because you want to pay off your debt (Although, that is a great idea!). In fact, not everybody who is in debt needs to stop spending on their wants completely. However, the fewer wants you purchase, the faster this process will go. Furthermore, anybody who is behind on their debt repayments needs to stop spending on all wants immediately. If you can not afford to pay your mortgage, you can not afford to pay for a cell phone. Period. After you get your debt under control, you may be able to revisit some of your wants – though you may find that you enjoy your simplified life and that you don’t really want all the extra distractions of having stuff.
Create a Zero-Sum Budget
The first key to getting out of debt is to know how and where your money is being spent. It is easy to let all kinds of money slip through the cracks if you are not tracking it. I know because that is what we did for years. However, learning to write a zero-sum budget is easy. All you need is a pen and paper. The best part about this particular type of budget is that it not only tracks where your money is being spent, but it forces you to consciously spend every penny that you make each month. Check out our article, My Zero-Sum Budget, My Friend and get yourself on track today.
Pay On Your Debt
Becoming debt free may seem like a daunting task, but we’ve all got to start somewhere. Rather than think about the enormity of your total debt, think about doing things in small segments. This will help you to stay on track and keep you from feeling overwhelmed.
Whether you owe $2,000 or $200,000, paying off your debt starts with paying on your debt. In general, the first thing you should do – if you are not doing so already - is to start making minimum payments on your debt. If you are not paying on your debt, how do you ever expect to pay off your debt?
So, let’s imagine that your minimum payment on your credit card is $40. Pay $40. Your minimum house payment is $1,200. Pay $1,200. While it may not seem like a lot, you have to get yourself in the habit of paying back these debts. Also, it is very important that you pay these debts on time! Paying late will only cost you more in fees and interest. Being that our goal is to pay these debts off, that would completely work against what we are trying to do.
If after cutting out all of your “want” spending you are still unable to make minimum payments toward your debt, you must then look for other options. First, you should consider finding a second source of income in order to pay off your debt. If increasing your income isn’t an option, you should consider selling some of the things which have caused you to be in debt in the first place. For instance, if you are swamped with car payments you can’t afford, it is probably time to sell the car. If you aren’t making enough money to afford your mortgage, you need to consider selling your house and renting. You may also wish to seek the advice of a credit counselor so that they can help you with your specific situation.
Building a Beginner Emergency Fund
Now that you are making regular minimum payments on your debt, the next thing you need to focus on is building an emergency fund savings. Since we have cut out all of our spending on wants, hopefully, our zero-sum budget leaves us some room for putting money in savings. You may need to start small. Maybe you can only save $50 a month. However, the more you trim, the more you should be able to save. Our goal is to save enough money so that we can take care of emergencies when they arise. For now, we should shoot to save $1,000-$3,000 as fast as possible. Once we have done that, we can move on to our next challenge.
The Debt Snowball
Here is where the real fun begins. After you have saved up enough money in your beginner emergency fund, you should stop putting money into savings. Rather than go out and spend that money on more wants, use your zero-sum budget to reallocate the money you had been saving to now pay off your debt.
Start by putting the additional money you had been saving toward paying off your smallest debt first. This money should be over and beyond the minimum payment that you were already making on this debt. Furthermore, you need to make sure that you are continuing to make minimum payments on your other debts. (Again, I stress that you must be paying these on time.) Once you have paid off the smallest debt, take that money and start paying it toward the next smallest debt. Like a snowball that picks up more and more snow as it rolls down a hill, you will be paying off larger and larger amounts of debt each time you finish paying off one of your smaller debts. Continue with this process until you have paid off all of your debt beside your house. (Paying off your mortgage is also a good idea, but should be used in your larger financial strategy, not as part of your debt snowball.)
Complete Your Emergency Fund
Congratulations! You’ve just become debt free. Now, don’t go out and do something stupid like going back into debt. What you should be doing is completing your emergency fund. I would recommend that you save somewhere between 6-9 months of your take home income and place it in an account that is liquid – like a savings account or money market account. From there, the sky is the limit. You can start saving for your child’s college education, invest in the stock market, or even save for that brand new car you’ve always wanted. Above all, remember to keep using that zero-sum budget so that you can carefully and consciously “spend” every dollar that you earn. Remember, pay cash for your wants and enjoy living debt free.