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If you're not doing this already you need to build an emergency reserve savings account. This will not only help you develop the habit of saving but it will create a cash cushion so that you won't be forced to create even more debt when you're hit by an unexpected emergency such as a trip to the ER or a big automobile repair bill.
Step 7: Make a plan for repaying your debts
You now should have everything you need to create your first debt repayment plan. And it doesn't have to be that complex. You really only need to answer three questions:
- How much extra money will you have that you can put towards your debt each month beyond just your minimum payments?
- Which debt will you pay off first?
- How will you prioritize your extra payments once you have paid off that first debt?
The information you got from tracking your spending will answer that first question. You have a couple options for answering the second and third ones. The most popular strategy for repaying debt is probably the debt snowball. This is where you line up your debts from the one with the lowest balance down to the one with the highest and then pay off the one with the lowest balance first. You then pay the one with the next lowest balance and so on. The thinking behind this strategy is that it will be motivating for you to see your debts paid off, making it more likely that you'll stick to your plan for repaying them.
The most popular alternative to the debt snowball is called the debt avalanche. It's where you put your debts in order from the one with the interest rate down to the one with the lowest and then pay off the one with the highest interest rate first. The logic behind this strategy is that you will save the maximum amount of money as the debts with the highest interest rates are costing you the most.
Which of these strategies you choose is less important than choosing one that you believe in and sticking to it.
Step 8: Don't forget your other financial priorities
Don't get so caught up in your plan for paying off your debts that you forget your other financial priorities. There may be some instances where you will want to put another financial goal first even though the goal of becoming debt-free is pretty fantastic. For example, you might put first the goal of getting life or health insurance or getting a will and doing your estate planning.
Step 9: Find an accountability partner to help you get debt free
As you’ve probably learned by now life can be full of ups and downs. It's important to have an accountability partner that understands what you're trying to accomplish, helps you stick to your repayment plan and reminds you of your successes along the way – to help keep you motivated. This could be a small group of people or it could be just one person that you can rely on for advice and encouragement as you work towards becoming debt-free.
Step 10: Get some debt relief
If you can reduce the amount you owe this will really speed up your path towards becoming debt free. If your biggest problem is student loans you should check out the three federal income-driven repayment plans. One of these can not only reduce your monthly payments but can even lead to some of your debts being forgiven. You could also do some little things like calling up your credit card issuers and requesting lower interest rates, which should mean more affordable monthly payments. You could also do something big such as refinancing your mortgage. Any or all of these can make repaying your debts easier and less expensive.
Step 11: Find ways to free up more cash
While this might go without saying, the more money you can put towards repaying your debts the faster you’ll get them paid off. The quickest way to do this is to find ways to cut your spending. Some of these can be pretty simple such as switching to a cheaper cell phone plan, cutting the cable, taking your lunch to work or un-enrolling yourself or your kids from some activities. There are also ways to get some big wins like moving to a cheaper house, trading in your car for an older, less expensive one or even ditching one of your cars and going to just one car for the entire family.
Step 12: Increase your earnings
We understand that cutting your spending can get you only so far. If that's not far enough you will need to look for ways to increase your earnings to get debt free. Fortunately, there are numerous ways to do this such as negotiating a raise at your current job. You might be able to find a job elsewhere that pays more or start what's called a side hustle. Finally, you maybe could even sell some of your stuff to raise extra money.
Step 13: Look for stories that will inspire you
You may start out incredibly motivated to become debt free but there will come times when you’ll feel frustrated and tired. Your accountability partner may be able to help you get through these moments. You can also find inspiration and encouragement from the stories of other people that have repaid their debts. There are numerous websites available with these kinds of stories so just search for them.
Step 14: Stick to it
The real truth here is that the most important part of your plan is not the plan but how well you stick to it. There's just no way to become debt free unless you continue working towards it regardless of the obstacles that life throws in your way. If things get tough, go back to the Why from Step one to remember why becoming debt-free matters to you. What this boils down to is the same as completing a half marathon. Just keep putting one foot in front of the other and before you know it you'll be debt free.
If you need a little help staying motivated, watch the following video to see how one woman stays motivated to get her debts paid off.
Frequently Asked Questions about debt
Q. Which debt should I clear first?
A. This question was pretty well covered in Step six. Which debt you clear first will depend primarily on whether you choose the snowball or avalanche method for repaying your debts. Beyond this, you might consider the effect that paying off a debt would have on your credit score. One of the biggest components of your credit score is called credit utilization. It's calculated by dividing the total amount of credit you have available into the amount you've used. If you do the math and find your credit utilization is above 40%, you might choose to pay off a debt that will get you below 40%, which could mean a boost in your credit score.
Q. What debt to equity ratio is good?
A. You can calculate your debt to equity ratio by dividing your total liabilities by your total assets. However, the debt to equity ratio is used mostly to analyze businesses. A better yardstick is your debt to income ratio. It's all of your monthly debts divided by your gross monthly income. A good debt to income ratio is 43% or less.
Q. Are debt consolidation loans a good idea?
A. This will depend entirely on the debt consolidation loan's interest rate. Add up the interest rates on your debts and then divide this by the number of debts you have. For example, if you have debt at interest rates of 15%, 19%, 17% and 18% your average interest rate would be 17.25%. Given today's interest rates you might be able to get a personal loan with an interest rate of 8% to 12% which would make a debt consolidation loan a good idea.
Q. What happens when a debt is sent to collection?
A. The first thing that will happen is that this will put a very black mark on your credit reports and will probably damage your credit score a lot. Beyond this, you will soon be hearing from a debt collector and this will not be a pleasant experience. Most lenders will not send a debt to collection until you have not paid on it for six months. You should be monitoring your credit reports so that you could possibly pay off an old debt before it went to collection, which would be the best alternative.
Q. How does debt affect my health?
A. The stress of dealing with debt can actually harm you physically. It can cause you to develop fibromyalgia, become depressed, suffer from migraines, experience muscle tension, develop low back pain and even have a heart attack.
Q. Who pays your debts when you die?
A. Any unsecured debts that are in your name only will likely die with you. However, joint debts will pass to your estate. For example, if you owed Wells Fargo $8000 in credit card debt that was only in your name and you died, that debt will probably be forgiven. But your other debts, such as a mortgage, will pass to your estate. Your executor will be responsible for managing the probate process (if your estate goes through probate) and paying off your creditors.