Debt Part 3 - Five Steps out of Debt

We started this series on debt, emergency funds and the debt to income ratio to determine where we are with debt. In this concluding article, we introduce five steps out of debt and two debt reduction plans that really work.

Five Steps out of Debt

Commit to Your Future and Live Within Your Means

We are Our Choices discussed starting with ourselves to write the next chapter of our life story with a belief in yourself, exercise your free will, and choose wisely.

There are no secrets here; you know what needs to be done and it is critically important to make a wise choice because it sets the path to your future. The first step is a commitment to yourself to live within your means.

You must stop using debt to fund your lifestyle. So, no more borrowing to finance furniture, cars, dinners out, Starbucks, or anything you can’t purchase with cash or pay off by the end of the month. High-interest credit card debt or any bad debt needs to be paid off as soon as possible.

Your current mission in this chapter of life is to focus solely on the bad debt and develop a plan to pay it off quickly.

Create a Personal Financial Plan

A Personal Financial Plan maps out the steps needed to achieve your goals considering your income, expenses, savings, debt, investments, and time frame.

It’s actually pretty easy to do and one or two pages long. The steps are outlined for you in these three articles:

Personal Financial Plan Foundation Part 1

It started with you and how you think about, feel about, and use the money. Here we look at your relationship to money; otherwise, your Personal Financial Plan may fail as you fall back into unknown habits that may hurt you.

Create a Personal Financial Plan Part 2

With a good foundation Part 2, we show how to set our financial goals and apply them to a single page worksheet to identify and evaluate options using examples.

The SMART Personal Financial Plan Part 3

Here we use your personal situation and options to make it a SMART Personal Financial Plan (Specific, Measurable, l Realistic and Time-based).

A Personal Financial Plan that tracks your income and your expenses is crucial because it gauges where you are and measures how and when you will hit your goals.

Here you may also need to consider how to create the extra cash to reach your goals sooner including cutting your spending on things that you don’t need or, perhaps a side job to earn extra money.

Establish Capacity for an Emergency of at least $500 to $1,000

We advocate making this merely a result of freeing up credit card capacity as discussed in the first article of this series under First Things First, Emergency Funds. Stuff does go wrong, and you need to be prepared for it.

We propose a less conventional but more cost-effective way to do this. Whatever your choice and comfort level you need a funding source for emergencies when they occur.

Pick One of these Debt Reduction Plans

Two widely used debt payoff plans are the Debt Snowball and the Debt Avalanche method. Both have broad support and testimonials because they work. Choose the one that will work best for you and how you think and feel about money.

Choose the plan that best meets your needs. Because, in the end, there is no wrong way to pay down debt.

Debt Snowball Plan

Dave Ramsey deserves a lot of credit for bringing the Debt Snowball Plan to the attention of many. Ramsey likes this method because it creates earlier victories or emotional wins. These, in turn, are further motivations to keep going on what could be a long debt reduction process for some.

The steps in the Debt Snowball reduction plan are:

List all debts in order from the smallest to the largest balance.
Pay the only the minimum on all the debt listed except the smallest balance debt.
Pay as much as you can on that smallest debt until it is paid off.
The next on the list now becomes the lowest debt.
Add the amount you paid on the first debt to the minimum payment on the next debt.
Repeat these steps until all bad debt is paid off.

You can read more and see an example on Dave Ramsey’s website here.

Debt Avalanche Plan

The Avalanche is the fastest and lowest cost method to pay off debt *provided you stick with it.* It is similar to Debt Snowball, except you list your debt in order from highest to lowest interest rate to pay off the highest interest rate debt first.

The steps in the Debt Avalanche reduction plan are mostly the same except how you order the list:

List all debts in order from the highest to the lowest interest rate.
Pay the only the minimum on all the debt listed except the highest interest rate debt.
Pay as much as you can on that highest interest rate debt until it is paid off.
The next on the list now becomes the highest interest rate debt.
Add the amount you paid on the first debt to the minimum payment on the next debt.
Repeat these steps until all bad debt is paid off.

In this plan, you need to pay attention to changing interest rates and reorder your debt payoff list to account for changes that may occur in the rates.

You can read more and see an example on the Investopedia website here.

Use any Excess Cash to Accelerate Your Plan

Use any extra money sources or side jobs to accelerate the five steps out of debt. These sources can include a tax refund, a raise, a part-time job, garage sales, you name it!

Set aside some money for a celebration after each debt payoff occurs. This is really a big deal and a testament to your commitment to finding your True Wealth.

Here’s a one-page Debt Payoff Plan with a table and summary of the steps you can use.

The Five steps Out of Debt are;

Commit to Your Future and Live Within Your Means
Create a Personal Financial Plan
Establish Capacity for an Emergency of at least $500 to $1,000
Pick One of these Debt Reduction Plans.
Use any Excess Cash to Accelerate Your Plan

Use the optional “Target Date” column in the Debt Payoff Plan to set payoff goals. The credit card calculator here can help you determine the payoff date.

Need more motivation? Use the credit card calculator under “miscellaneous” on this site to see how long it takes to pay off a credit card balance using the credit card company’s minimum payment (usually 2% of the balance).

You’ll see how many years and all the interest if you pay only the minimum payment required.

Another useful (and free) tool compliments of Utah State University Extension is Power Pay you might want to try.

Other Methods

Other methods include introductory lower interest rate credit cards, debt services, settlements, debt consolidation loans. And, some may be helpful depending on your personal situation.

For example, consolidation loans often lower monthly payments and can offer a lower interest rate. However, extended loan terms can result in higher overall interest costs due to the longer duration of the debt.

But first, do your homework and proceed with caution because there can be pitfalls.

We know the Five Steps out of Debt using either the Snowball or Avalanche Plan works. Many have benefited from these plans based on users testaments. The recommendation is to focus primarily on the five steps out of debt.

Wrapping Up Debt

OK, let’s wrap up our discussion on debt starting with some soul searching. How did I get here? Was it an unforeseen emergency or medical expense? Or, was it my behavior like spending more than I earn?

What matters now is what you learned from that experience. Embrace any mistakes made. They are life’s lessons, turn them into a future competitive advantage.

Let any lessons learned make you more resilient not regretful. You already know living from pay check to pay check is not a way to live. Implement these Five Steps out of Debt. Choose to change the behavior that created the debt.

Remember, this is the first day of the rest of your life and the opportunity to start writing yourself a great story. Congratulations, you are now on the path to True Wealth.