How To Become Debt Free
How to Manage, Reduce, and Eliminate Your Worst Debts
Managing large amounts of debt isn’t easy to do. But getting started is critical. No matter how small of a step you take to start managing, reducing, or eliminating your debt… taking that first step is critical to your success.
Step #1: Figure Out How Much Debt You Actually Have
So your first step is to figure out exactly how much debt you have. When you do this step, take into account all debts:
* Home loan/mortgage balance
* Student loan balances
* Credit Card Balances
* Automotive loan balances
* Other Credit Line Balances - Gas cards and accounts, revolving store credit accounts, etc.
* Current or back taxes
* Any ongoing contracts you’ve committed to such as cell phone services or gym memberships.
Regular monthly bills are not considered debts. Your electric bill for instance, is paid as electricity is used. The same applies to the phone bill, water and trash, cable, and other regular bills. Since these aren’t credit accounts, they would not be listed in your total debt analysis.
Cell phone bills however, should be listed as a debt if you have a binding contract with your cell phone service provider. Most cell phone service accounts are under a two year contract for instance, and if you’ve had your service for just 6 months, you’re obligated to pay that bill for another 18 months, thus the cell phone service is a debt.
Once you’ve listed every single debt obligation you currently have, you should now go back through the list and note down two other major details:
1. Total amount of the outstanding debt for each one.
2. Interest rate for each debt item.
At the end of step one, you should have a complete picture of just how deeply in debt you are. It may not be as bad as you thought, or it may be worse than you thought. Either way, you now know the exact amount of debt you need to manage, reduce, or elimate. You know who or what it’s for, how much the total outstanding amount is, and how much extra you have to pay on that debt regularly.
Step #2: Decide What Your Personal Debt Relief Goal Is
Once you have the full picture of just how deeply in debt you are, you need to decide what your debt goal is.
* Do you want to become 100% debt free?
* Do you want to reduce your total debt by a certain percentage?
* Do you want to simply stop bill collectors from calling and harrasing you?
* Do you want to reduce the amount of cash flowing out of your home each month?
* Do you want to put some money away into savings or investments?
* Do you want to reduce, remove, or simply slow down the debt’s growth rate from interest?
Your reasons for managing, reducing, or eliminating your debts are entirely personal. Knowing what they are is an important step towards taking effective action though, so sit down and think about this question a bit.
If your goal is to become debt free, you might choose a different debt management and reduction plan than you would if you simply want to put away extra money into savings for instance.
So, decide what your debt relief goal is, then right that down at the top of your debt list assesment page.
Step #3: Put Your Debts in Order
The next step is to rewrite your debt assesment list. You need to put the debts in order, either by the total amount of the debt, by the interest rate, or by the urgency of the debt.
If you put them in order by amount for instance, you’d put the largest total debt first, with the second largest next, and so on.
If the debt’s interest rates are killing you, you might choose to order your outstanding debts according to interest rate amounts instead, since those total outstanding debts tend to grow faster when interest rates are higher.
The third organization option is to list your debts according to urgency. If for instance, you have an outstanding credit card bill that’s 180 days past due, you might choose to list that before the credit card debt that’s current.
Some debts tend to escalate into much larger problems if they’re put off, so managing debts by their urgency can help take a load of weight off your shoulders.
How you organize and prioritize your debts is a completely personal decision. The important part is to get them prioritized so you’ll know which steps to take when. Again: Having the full picture of your debt problems is a major step towards managing, reducing, or eliminating those debts.
Step #4: Is it Good Debt or Bad Debt?
Now you’re going to rearrange your debt list again. This time you need to create two lists: Good debt and bad debt.
If you have a debt that is generating an income stream - say a rental home or monthly payments on your retail business space - this is good debt. Yes it’s debt, but because it brings income in, it’s a good debt. So list these in the good debt column.
If you have debt that is sucking you dry however - or at the very least not giving you anything in return - these will go into the bad debt column. Debts of this sort usually include credit card bills, car payments, and revolving credit accounts.
Now, your home mortgage could go into either column. On one hand it can be considered a good debt because you’re building equity. On the other hand it could be a bad debt because it’s too expensive for you, the taxes are too high, or it needs too much money in upkeep.
Your car is another example of something that could go into either column: If your car is required in order for you to do your job or run your business, it could be considered a good debt. If on the other hand, the payments and insurance are outrageous, or the upkeep is simply draining your pockets each month, it’s a bad debt.
Regardless of how you list various debts, it’s imperative that you’re honest about whether the debt is actually a good or bad debt.
Once you’ve made your good and bad debt lists, you then need to go over the good debt list with a hard look at reality. Think earnestly about whether your good debts are excessive. Is that gorgeous luxury car really needed to conduct business profitably? Does it actually make a difference in how much income you earn? Or could one a few years old do the job just as well? Would a more moderately priced model give you just what you need for work without having the extra payments and insurance coverage?
I’m not saying you need to get rid of or downgrade items in your list, but if reducing or eliminating your debt is important, you should seriously consider your options and alternatives… even with the items on the good debt list.
Step #5: Make an Honest Cash Flow Assessment and Budget
Now that you have all your debts in order, it’s time to make an honest, full assessment of your cash flow. You can call this making a budget if you’d like, or you can simply call it a cash flow assessment. Either way, you need to know exactly how much money comes into your household each and every month. Just as you needed to know how much debt you have, you also need to know how much resources you have to deal with that debt.
So figure out just how much money comes into your hands every month. This needs to be spendable money, not gross income.
Once you know exactly how much comes in, now you’ll need to figure out exactly how much goes out again for necessities. These are things that are needed to live: mortgage payment, utility bills, groceries, etc.
First list only those things that are absolutely needed each and every month. If you don’t have an exact amount, use a generous estimate. The electric bill might range from $250-$300 each month for instance, so write it down with the high amount just to be safe.
Now that you know exactly how much money you have coming in, and how much must go out each month, you can discover your disposable - or extra - income.
Subtract the total amount of your neccessities list from the total amount of your income. This is how much extra you have each month.
Now if you’re like most of us, you spend a lot of that on misc things here and there. Maybe you stop for an extra coffee on the way to work, or you go out to lunch regularly, or you pick up a movie and pizza on the way home. It all disappears pretty quickly.
Many of us are actually surprised by how much extra money we have in a given month when we list it all as noted above. And many of us had no idea we were squandering that extra here, there and everywhere without notice.
Looking at it on paper though, there’s usually a decent amount left over after the neccessities are paid for. Since you’re in debt of course, much of your extra money probably goes towards trying to keep those extra bills in check. So let’s move on to some debt management and reduction strategies.
Step #6: Choices: Reduce Debts or Interest Rates
Which is More Important? Reducing the number of debts you have or getting rid of the highest interest eaters first?
You need to make another honest personal decision. Ask yourself which is more important? Do you want to reduce the number of debts you owe; reduce the total outstanding debt you owe; or reduce the debts with the highest interest first?
If for instance, you want to reduce the biggest interest debts first, since these tend to rack up even more debt faster than anything else, you’ll want to go back to step three above, and list your debts in order of interest rates.
If you want to tackle the debts by amounts, then having them listed by amounts in step three is more important.
Step #7a: If you want to reduce the number of debts…
If you want to reduce the total number of debts you have, then the simplest way to do this is tackle the smallest first. Order your list of debts according to what is owed, and the last one on the list should be your smallest outstanding debt.
In some cases, this debt is small enough for you to simply write a check for it right here and now. If that’s the case, then do that and put it in the mail. Then mark that debt off your list.
If your smallest debt is not something you can pay off immediately, then look again at your income and outgo lists. Are you able to contribute an extra $20 a month towards this debt? If so, you’ll reduce and eliminate this debt faster.
Step #7b: If you want to cut the debt interest rates…
If instead you need to cut through your higest interest rate debts first, then you’ll have organized your debt list by interest rate. So you simply take the debt that has the highest interest, and start applying more money towards it each month. Again, even an extra $20 per month will drastically reduce the debt in a quicker amount of time, and make a huge difference in the amount of new interest generated.
Step #8: Debt Reduction on Steroids
Whichever way you choose to tackle your debts: By interest rates or reducing the number, there’s an ongoing trick that will help escalate the rate in which you pay off those debts.
Each time you pay off a debt, apply the amount you were paying on that debt to the next one.
So for instance, if you choose to pay off your smallest debt first - this is the easiest way to start reducing and removing your debts by the way - then once that first debt is paid in full, you’ll add the money you were using to pay that debt to the next one.
So, let’s say you’re paying off $1000 in credit card bills by making $100 payments each month. In 10 months that debt is now fully paid. So instead of spending that $100 on fun stuff in month 11, you’d add that $100 to the next debt you plan to pay off. If that next debt is normally paid in $50 monthly increments, you’d now start paying $150 towards it each month. By doing so, that debt will be completely eliminated three times faster than it would have paying just $50 a month towards it.
And again, once that next debt is paid, you now have $150 to add towards the third debt goal.
This is the true key to successfully reducing debt fast, and it can play a critical, fast role in helping you become 100% debt free as well.
Final Debt Management and Reduction Tips
Managing and reducing debt is all about keeping your spending under control. When you pay off a credit card for instance, don’t run out and max it out again on stuff you don’t need.
Keep your debt list somewhere where you’ll see and review it on a daily basis. Completely knowing just how much money you owe will help keep you focused on your debt reduction and debt management goal.
Keep your cash flow or budget plan on hand too. Review it regularly and force yourself to stick to the plan as strictly as possible.
Allow room for fun and flexibility. Managing, reducing, or removing all your debts is an amazing feeling, but it can be a long, hard struggle. You may often find yourself feeling deprived or punished because you can’t go buy that new outfit, or go out to eat, or see a movie. If you’re too restrictive with your spending, you’re more likely to completely blow everything in a fit of frustration. So instead of cutting out movies all together, allow yourself a smaller allotment each month. If for instance, you’ve been spending $50 a month on movies, reduce that to $10 or $20 instead of removing it all together. This way you’ll still be enjoying your day to day existance instead of feeling completely deprived, poor, or broke.
Reward yourself. This can be tricky because if you’re not careful you’ll end up splurging. But each time you have another debt fully paid, take the next monthly payment and use it to splurge on yourself. Buy something you’ve been wanting, go somewhere special, whatever. Just reward yourself. Only do it that once though, then the very next month start applying that extra money to the next debt you’re planning to reduce and remove.
Managing your debt effectively is difficult, but it’s not impossible. With a bit of persistance and commitment, you’ll soon find yourself breathing much easier… and on your way to becoming 100% debt free!
Next Steps: Explore all resources you can find, online or off, and get started reducing your debts right now!
© 2006, Kathy Burns-Millyard. All Rights Reserved.
