Most of the readers of this blog probably do not have debt, but since you ended up reading this article, you probably have debt that you want to get rid of. If you are still unsure of whether debt is bad for you, check out my article on why debt is a personal emergency (!!).
Now that we agree on that, let’s cover a few steps on how to get your debt spaceship safely back to Earth!
I used to have debt of around $20,000 myself. You wouldn’t believe all the weird things I used to spend my money on. I used a few years on paying back my debt with all of my left-over money by following the seven steps below.
I recommend using the seven steps to get rid of your debt, but remember, I am not an expert or financial advisor, so always seek professional advice – and know that different approaches work for different people.
1. Pay down your debt before starting to invest
If you have debt and have money invested in any assets, I would recommend selling it all and using that money to pay down your debt.
I used to have money in a few stocks while still having $20,000 in debt. That was stupid.
Often the interest rate on debt is higher than what you would be able to generate of returns elsewhere. If you have 15% interest rate on debt of $10,000, you are losing $1,500 per year. You better stop that open wound – and quickly! Saving $1,500 on interest is the same as making a return of $1,500 on an investment. Most people agree that you can rarely make more than 15% in return in a normal market, thus paying off your debt before investing would always be the sound financial choice.
I know it is fun to invest and see your money grow, but it is not fun if all the money goes to pay off interest. Also, the feeling of being debt free after being in a lot of debt is unbeatable – believe me, I have tried it.
2. Be aggressive and make a budget
Pay off as much debt as you possibly can with your current income. Get an overview of your monthly take-home income and monthly expenses. Try to cut all of your expenses as much as possible, thus increasing your savings rate.
Many people have written about how to make a good budget, but you can see my budget and approach here. I recommend splitting your expenses in two: need to have and nice to have. The latter you can always cut away, although it might come at the expense of your life quality. In times of debt, you might need to cut down on this to gain an even better future! Be aggressive in setting (realistic) targets and cut down on all other expenses in your life as long as you pay off your debt.
3. Start from the top
Make a list of all of your loans and prioritize them from highest interest rate to lowest. The loans with the highest interest rate should be the ones you pay off first.
Paying off the loans with the highest interest rate first makes best financial sense, but if you want to get some psychological victories, try to eliminate some of the smaller loans first (based on amount).
4. Set short-term and long-term goals
Use your new budget (step 2) and debt payment plan (step 3) to set monthly and yearly goals to make sure you are tracking your progress. Evaluate your progress frequently to make sure you stay on track. If you are not on track, find out why and address the problem head on.
5. Never take out any new loans
This one is self-explanatory, but please, please, please, do not take out new loans. Unless, of course, it is some of the debt that is ok to have, but really, if you are already in heavy debt, no debt is ever ok to have!
6. Get rid of your credit cards
I mean it, get rid of your credit cards. You are losing money by having them – and especially by having many of them! If you need one, keep one, and only one. Make sure to pay off all of the debt each month at low or no interest. Don’t go for the minimum payment. As an example, if you pay the minimum payment of 3% of your debt every month it will take you close to 20 years and cost you more than double the original loan amount at an interest rate of 20%. How’s that for a super bad deal?
7. Get that warm and fuzzy feeling
Nothing will feel as good as getting on the other side of debt. It will feel like a long road, and it might take some time depending on how much debt you have. Keep going and I promise you that you will get a warm and fuzzy feeling, and you will be able to start saving money and building your future, much more worry-free life!
Once you get rid of your debt, you will be able to plan your life much better. I am on a journey to retire at age 33 in 7 years from now – you can read about my journey here.
I noticed that Kalen @ Money Mini Blog has put together a list of good books on debt if you are interested in reading more.
Do you have any other tips on how to get out of debt? Let me know in the comments!