Excerpt from Getting Out of Debt: A step-by-step guide, a LifeWorks booklet written by Hal Morgan,.
Getting Out of Debt: A step-by-step guide
Getting out of debt takes time, commitment, and sacrifice. While this booklet is written to be quick and easy to read, some of the steps it offers will take work and perseverance. The emotional strain of living with a debt problem can be intense. But the road to financial security involves some emotional challenges, too. You’ll need to decide that the pressure you face from your debt is worth the self-discipline it will take to retire it and get back on firm financial ground.
Why do we often act in irrational and self-destructive ways with our money?
A big part of the answer is that we aren’t calculating machines. We aren’t very rational. We’re human beings with complex emotional needs. And access to money and credit plays to our emotions in ways that are hard to control.
At a primary level, there’s the tension between “now” and “later.” Spending brings immediate pleasure. We don’t enjoy the benefits of saving—or the pain of debt payments—until later. We may think of ourselves as mature adults, but there’s still a lot of the two-year-old in each of us. “I want it now” can easily overpower “But think about later.”
The way we behave with our money is also deeply rooted in our experiences, especially in childhood. For example, if you grew up with a parent who was a disciplined saver and never spent money on fun extras, you may find it easy to follow that model yourself. Or you may find yourself behaving in ways that are a reaction against that early experience. At a level you may not even be aware of, you may view savings as an unhealthy form of self-denial and spending as a way to achieve a more balanced and happy life.
When your debt total is going up instead of down it can leave you feeling trapped, desperate, and not in control of your life. You can feel that someone else “owns” you, to the point that you deny yourself the breaks and pleasures you need to stay healthy and happy. A debt problem can drain your sense of confidence and self-worth. It can lead to depression, unhealthy anxiety, and health problems. The emotional effects can damage your marriage and your relationship with your children, friends, and extended family. Money problems are the single biggest factor in relationship problems that end in divorce. Debt problems can affect your performance at work, pushing you to overwork in a “nose-to-the-grindstone” way, and keeping you from contributing with energy and creativity in ways that add value to your employer and lead to bonuses, raises, and promotions.
Debt is clearly a two-edged sword. Used wisely and carefully, it can help bring you greater happiness and prosperity. Used casually and without careful planning, it can lead to economic crisis and intense emotional stress.
Four steps to reduce your debt
1. Admit that you have a problem and commit yourself to fixing it.
Only you can solve your debt problem. And you can only solve it if you decide that it’s a problem worth solving.
There are a few ways of making that commitment. Some experts recommend writing a statement owning up to the problem and signing it. Others suggest that you call a family meeting and have an open discussion of the debts you face. A debt problem is rarely felt or solved by just one person, and the ideas and efforts of every member of the family may be needed to get you back in the black. People often find that this open acknowledgment of a debt problem is a relief to the others in their families. And it usually comes as no surprise.
The other effective way to make a commitment to solving a debt problem is to talk with a financial counselor or attend a meeting of others with debt problems. Talking about a problem pushes you to admit to yourself that you really do need to take action. Knowing that you’ll be expected to talk again to that same person or group and report on your progress is also a powerful incentive to act—and to stay on track once you start. And finding other people who understand your problem and who have come up with ways to deal with similar problems can be a huge relief if you’ve been shouldering this worry yourself for a long time.
2. Stop debt spending.
Take your credit cards, store cards, and gas cards out of your wallet or pocketbook and put them in a secure, out-of-sight location at home. Starting right now, get through an entire day without borrowing money or charging anything. Pay cash or use a debit or ATM card.
You’ll find that this in itself cuts your spending and pushes you to make only planned purchases. It will also show you what life feels like without debt spending. Most people are surprised at how easy it is to make the switch. A bank debit (or ATM) card is an easy alternative. It can be used just like a credit card, but without the debt effect. The money comes right out of your bank account every time you use it. Once you get through today, you can decide about the next day. And if you manage that, take on another day.
After a week or so of no-debt spending, you’ll be ready to make an even bigger commitment. Keeping credit cards in a drawer at home is like closing a gate on a problem and not locking it. If you have a real debt problem, you need to lock the gate. Cut up your credit cards. And cancel the credit reserve or overdraft feature on your checking account. This will feel like a drastic step—like slicing through your safety rope when climbing a steep cliff. But in fact it’s the access to credit that’s the biggest danger to you until you get your debt down to a healthy level. Later on, once your finances are back under control, you can decide to ask for a new copy of one of your cards.
3. Make a spending plan.
A “no debt spending” policy will push you to pay more attention to your spending. The next step is to get a clear picture of that spending and develop a new spending plan.
You might think you already know how you spend your money. You know what your rent or mortgage is. You have a good idea of how much you spend on groceries. You may know how much you spend on transportation or gas. But without tracking your spending, you’ll find you don’t really know where all of your money is going.
If you doubt this, take out a piece of paper and write down how much you made last year. Then total up those big categories of expenses you can track in your head. When you compare what you made to what you spent—at least in this quick measure—you’ll probably find that you should have ended the year with extra cash to put into a savings account. How does that compare with what really happened?
The reason it’s such a valuable exercise to track spending is that we have too many expenses to keep track of in our heads. And it’s the daily cash spending and the extra expenses—like car repairs, meals out, or holiday gifts—that push us into debt spending.
Track your cash spending. Try it for a day. You’ll be amazed at how easy it is and how much it shows you. It takes just a minute or two to make the notes over the course of the day, and for that small effort you’ll find out just where your money is going. You won’t wonder any more what happened to that $50 or $100 you put in your wallet. You’ll know.
Once you see how easy it is, keep going. Track your cash spending every day for a week.
Track the checks you write and payments you make with debit or ATM cards. Paying by check or debit card is the other main way people part with their money. If you’re in the habit of recording every check you write and every payment you make with your debit card, that’s good. If you’re not in that habit, now is the time to start. Every time you write a check, write down the number of the check (so you can be sure you haven’t missed any), the date, to whom you wrote the check, what it was for, and the exact amount of the check (to the penny). Every time you pay with your debit or ATM card, write the amount in your checkbook register just as you would with a check.
With this information in your checkbook register and the notes you’re making on your cash spending, you’ll be able to build a complete picture of your spending over time.
Combine your notes into a weekly and monthly spending record. Once you have a few days of information on your spending activity, the next step is to start combining your numbers into a weekly and monthly spending record. A monthly record is the most useful measure, since so many expenses fall into a monthly cycle. A simple way to track spending by week so that you can total it up by month is to divide your weeks according to the days of the month.
Make a spending plan. If you’re like most people with debt problems, you’re in your current financial state simply because you’ve spent more than you earn. Now that you see how much you’re spending (in the chart on the previous pages), you can make a plan to cut that spending to a level that will not only keep you from adding to your debt, but let you pay down your debt more quickly.
When most people begin to track their expenses, they find a couple of big surprises which then become the biggest opportunities for trimming their spending. It might be meals out. It might be books or movies. It might be car expenses. Whatever the surprises are for you, start there. The far right column of the chart, labeled “Spending Plan,” is where you should write down a realistic new goal for that category of spending.
In some cases, when people line up their expenses with their income, the expenses are so much higher than the income that drastic steps need to be taken. They may need to sell an expensive car and replace it with a less expensive model, or perhaps get rid of the car altogether and rely on carpools or public transportation. They may need to move to less expensive housing. This can happen when income is cut back, either through a change to a lower-paying job or a reduction in overtime pay. It can also happen when people move into a higher-paying job and overestimate how big an impact the change will have on take-home pay. If you’re in this situation, it may help to talk with a debt counselor to get an expert opinion on what’s pushing your budget so far out of balance. A good financial counselor can help you understand whether a drastic change is needed.
Almost always, though, it’s not the home or the car, but the casual spending on meals out, music, movies, electronic equipment, and other “impulse” extras that have to be trimmed to make a healthier spending plan. And extra money can almost always be found through smarter shopping for the things now bought at too-high prices.
The goal of a spending plan is actually very modest: to bring expenses into line with income, so that you stop adding to your debt, and to come up with an extra $50 or $100 a month to put toward debt repayment.
Make an earning plan. For most people, the key to getting out of debt lies in more careful spending. But you may also have some opportunities to increase your income, which is the other way to come up with more money for debt repayment. Just be careful not to let your debts push you into a miserable grind of round-the-clock work. The goal is to get your debt down to a level where it no longer controls your life. You want to be in control of your money and your life.
4. Pay down your debts month by month. Pay them off one by one.
The next step is to make a list, using the form on the next page, of all the debt payments you make each month. Include payments on credit cards, store cards, installment loans, home equity loans, payments to repay personal loans to friends and family—payments on everything you owe to anybody. (Don’t include mortgage payments. Like rent, they are a basic housing cost. And unlike your other debts, you can pay off your mortgage at any time by selling your home.)
For each debt, list
- The name of the creditor (the bank, credit card, business, or person to whom you owe money).
- What you normally pay (what you’ll pay this month if it varies).
- The total amount you owe (the exact amount from your most recent bill or statement).
- The annual interest rate that is applied to the balance. (If that interest is set at a special low rate for a limited time, write down the date that it will go up.)
Once you write this information on a list, it’s easy to see how big or how small your problem is. Knowing the actual number grounds you in reality and lets you get down to the business of chipping away at your debts to make them smaller and more manageable. When it comes to getting out of debt, knowledge really is power.
Now you’re ready to come up with a debt repayment plan. If you can find another $50 or $100 each month to pay toward your debts, you can start to wipe them away—one by one, month by month. Even less than $50 can be helpful.
Look at your list of debts. Choose one to pay off first. It should either be the one with the highest interest rate or the one with the lowest balance. It’s your choice. The one with the highest interest rate is costing you the most every month. You’ll make a bigger impact on your spending if you pay that one off first. But the satisfaction of paying a loan off completely is an important motivation, and that will happen sooner if you choose the loan with the smallest balance.
Starting this month, add your extra debt-payment allowance to your payment toward the debt you’ve singled out. So if you had been paying the minimum of $20 a month on a credit card bill and you’ve decided you can add $50 to your debt payments, you’ll pay $70 a month toward this card. Keep making your regular monthly payments toward the other debts. You’ll get to them next.
An extra $50 or $100 payment every month may not seem like much, but it makes a huge difference in how long it takes to repay a debt and to the total amount you pay. An extra $50 per month can reduce the time it takes to pay off a $4,000 credit card balance from 45 years to less than six years. And it can reduce the total amount of interest you pay from more that $11,000 to less than $2,000. Paying an extra $100 per month reduces the payoff time to just over three years and the total interest to just over $1,000.
As you focus your repayment efforts on that one debt, you’ll have the satisfaction of seeing the balance shrink over the course of several months until it finally disappears. When that happens, it will be time to move on to the next debt. (As with the first one, you decide whether it’s the loan with the smallest balance or the highest interest rate.) And here’s where the magic of interest rates starts to work in your favor. When you pay off the first debt, you free up the money you were paying in interest on that loan. Now you’ll be able to pay even more each month toward the second debt. And the speed of your repayment plan will begin to pick up.
Stick with it.
This four-step plan is a sure-fire way to reduce your debts. It’s a strategy that’s worked for thousands of people who have overcome serious debt problems. It’s the basis of the support offered through professional debt counseling and through groups such as Debtors Anonymous. But it’s not a quick fix. It takes time. And it takes your steady commitment to stick with the plan.
You may be tempted to skip a month sometimes or to make an exception and charge something on a credit card or store account card. Nobody will stop you. It’s your money, your debt, and your responsibility. But from your own math and the graphs in this booklet, you can see that any slips will set you back and delay the success of the plan. Just as debts can “snowball” and build up to get you in debt trouble, so a debt repayment plan can snowball in the opposite way, picking up speed and becoming easier as you shed more and more of your debt interest payments.