Personal Finance Essentials
How to Get Out of Debt
The Exact Steps to Eliminate Every Debt You Owe
Starting Today
Using a computer spreadsheet or a plain sheet of paper, create four columns:
Column 1
Column 2
Column 3
Column 4
Sort the list based on Column 3, so the highest interest rate you are paying is on top. Make the minimum payment each month to each creditor as shown in Column 4. Never skip any of these payments.
Send all your remaining cash to the creditor at the top of your list – the one charging you the highest interest rate. If you have any cash left over after eliminating that debt, apply all remaining cash to the next creditor, and so on, until all your debts are repaid.
This process could easily take years – just as it took years to create the debts in the first place. To accelerate your efforts, withdraw any money you have in bank accounts and sell whatever assets you have – from savings bonds to stocks, collectibles to jewelry – and use that money to reduce your debts.
How People Get Into Debt
Nobody intends to become debt-ridden, but at some point you may look around and wonder how you got there. It starts very innocently. We start life with a clean slate, but then we make bad decisions or fall into traps. The most common trap is committing yourself to a future lifestyle based on your current income.
Consider Debbie, 23 years old, living with her parents and earning $23,000 a year. When her car died, she intended to buy a modest vehicle for about $15,000 – but ended up financing $20,000 for a car costing $28,000. Her monthly car payment became $445 for five years. Combined with insurance and maintenance, that wiped out 43% of her take-home pay. To get by, she started putting gasoline on a credit card. Then clothes. Then holiday gifts. Soon she had built up thousands in credit card charges she couldn’t pay off each month.
The second common trap is failing to adjust your spending when life changes. Couples who become parents, people who take on new expenses, anyone whose circumstances shift – if your spending habits don’t change to reflect the new reality, debt accumulates. One couple, Lon and Gretta, had managed their credit cards perfectly for twenty years. Then their first child arrived. They kept spending the way they always had, without adjusting for their new obligations. By the time they sought help, they owed $30,000 in credit card debt.
Why Target the Highest Interest Rate First
Most people instinctively want to pay off the largest balance first. That instinct is understandable but costly. The correct approach is to pay down the debt with the highest interest rate first, regardless of the balance. Interest accrues every single day you carry a balance. Focusing on the most expensive debt first stops the bleeding as quickly as possible. After that debt is gone, move all your remaining resources to the next highest rate, and keep going until all debts are cleared.
While you are working toward eliminating your debts, do not add to them.
The Balance Transfer Strategy
There is one additional tool available: borrowing at a lower interest rate to pay off a higher-rate debt. If you can obtain a new line of credit at a lower rate than what you are currently paying – and if the total amount you borrow is no greater than the total amount you already owe – this can reduce the cost of your debt while you work to eliminate it. For example, if you owe $5,000 on an 18% credit card and can transfer that balance to a card charging 14%, you will pay less in interest each month.
Be careful, though. Many card issuers offer low introductory rates that expire after a few months – sometimes jumping to rates higher than what you were paying before. In other cases, the low rate applies only to new purchases, not to balances transferred from another card. Read the terms carefully. This is a temporary measure, not a solution. The goal is to eliminate the debt, not simply make it cheaper to carry.