Why is it that getting into debt happens so quickly and easily while getting out of debt is like a slow torturous climb from the abyss? Borrowing money is an instant solution for many of life's problems like being able to go to college, having a car, furnishing a house, going on vacation, having expensive clothes and the list goes on and on. The thought process is universal - “I can buy and enjoy things now and pay them back slowly over time or pay them off in full once I am making more money.”
Here are the three big problems with this thinking:
1. The interest rates on most unsecured debt makes it very hard to manage. Things can get out of control quickly because the interest payments alone are unaffordable.
2. You have no money to invest - Investing in assets early on in your life is the secret to becoming wealthy. Having bad debt like credit cards and personal loans prevents you from getting started.
3. Who knows when and if you will make more money. What if you hate your job? What if you lose your job? There are too many unknowns to depend on your future income to pay off today's purchases. It is easy to justify your decisions with this thinking, but it just doesn’t always work out this way.
So once you find yourself under a mountain of debt how are you supposed to turn it all around? I wish there was a simple answer, but unfortunately there is not. Let's go through the necessary steps to get out of debt.
#1 Become obsessed with getting out of debt. It may sound cliche or silly, but it is very real. It’s similar to losing weight, you do not stand a chance unless you really want to do it and commit 100% to achieving your goal. There is no half assing this one...either you’re gonna do it or your not. Question every time you are going to spend money. Do you need to buy whatever it is or can you instead use that money to get closer to your goal?
#2 Make a list of all your assets and liabilities. This is also called a net worth statement. This should take no more than 10 minutes. A big reason we do this is to get an overall picture and see if there are any assets that would be better used to pay down some debts. Here is an example:
#3 Create a list of where your money goes each month. Start with your fixed expenses like rent, mortgage, car payment, cell phone bill and then list out variable expenses like groceries, eating out, entertainment, gas etc. This is known as a cash flow statement. It is impossible to make the necessary changes if you don’t know where your money goes each month. Here is an example:
#4 Make a list of every bad debt that you owe starting with the smallest balance. Include the interest rate, minimum payment and outstanding balance for each debt. Here is an example to follow along:
Print this list out and hang it all over the place.
#5 Start attacking the first debt on your list. Pay the minimum payment on all the other debts while doing whatever is humanly possible to pay off that first outstanding balance. This means you may need to work overtime, get a second job, or sell things on Ebay all while becoming obsessed with cutting your monthly expenses to the bone.
Let's make the assumption you can pay an extra $400 per month towards your debts through a combination of cutting expenses, working more and selling some stuff around your house on Ebay. That means you would be paying a total of $425 a month towards that Chase card and it would be paid off in just about 3 months.
Once it is gone you then take that $425 that was going towards Chase and add it to the American Express payment of $40 for a total of $465 each month. It would take about 4 ½ months to bang out the Amex.
The snowball is getting bigger!
You can now take the $465 that was going to the Amex plus the $96 minimum payment for a total of $561 and put it all towards the Wells Fargo card. It will take about 8 ½ months to knock out that Wells balance.
After 16 months of hard work and sacrifice you were able to eliminate $8,300 of credit card debt! Let’s keep going.
Next up is the car loan. You can now take the $561 you were paying towards the Wells Fargo card and add it to the minimum payment of $220 you are already making towards the car for a total of $781 per month. The $11,000 car loan will be paid off in 14 months!
Finally...all that is left is the $23,000 student loan. You can take the $781 that was going towards the car plus the $200 payment you were already making towards the student loan for a total of $981 per month. At that pace the loan will be paid off in 2 years.
In total you will have paid off $42,300 of debt in 4 ½ years.
Final thoughts: We are making a big assumption that you will be able to either add income or reduce expenses by $400 each month moving forward. If you can do more it speeds this process up, but if you not able to make this happen then it is nearly impossible to get going.
4 ½ years seems like a long time, but the real light at the end of this tunnel is that you will have learned to live without using debt and in this example you will have an extra $981 a month to start building your assets. Not to mention any pay increases you might have received along the way.
Getting out of debt is the first step to a happier and less stressful life. It will give you flexibility and freedom. Go make it happen.