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7 Steps to getting out of debt

Updated on June 30, 2014
Debt can quickly becoming overwhelming! (Photo by, Steve Woods)
Debt can quickly becoming overwhelming! (Photo by, Steve Woods)

People accumulate debt for a number of reasons. Some are unavoidable such as a health crisis or loss of work from disability. But often, the root cause is a learned behavior of living beyond one's means. Spending more than you earn is a surefire way to a life of debt. It's also the most prominent reason.

If you fall into this category, then I hope this article will help you to work your way out of debt. However, if you have accumulated a large amount of debt due to loss of income from disability or illness then you should seek professional assistance and find a Debt Counselor.

Some people believe that all debt is bad debt, while others divide debt into discrete categories that fall between good and bad debt.

As a general rule of thumb, debt is considered "good" when it is used to pay for an asset that appreciates in value faster than the debt payments expend your resources. Student Loans and mortgages often fall into this category. Interest payments of this type of debt also tend to be tax deductible, at least partly.

Pretty much any other type of debt falls into the bad debt category. This is typically known as consumer debt. Items in this category include credit card debt and personal loans. Car loans usually fall somewhere in between as they are used to purchase a liability (automobiles tend to go down in value as well as require regular maintenance and upkeep), but that liability usually carries some value, whereas credit card debt does not.

The good news is that getting out of debt and learning to avoid it in the future are attainable goals if you follow some simple principles. The principals of debt management are simple, but the process can be difficult at first due to the discipline and persistence required. That's the hard part, but these 7 steps should help you get out of debt and keep you on the road to a debt free life.

DISCLAIMER: There are numerous avenues for debt management advice from free articles on the Internet to professional consumer debt counseling. There are also many debt solutions to be found. I offer 7 simple steps that have helped me to eliminate just over $10,000 in debt in 18 months. To be fair, it was 18 months of determination, discipline and sacrifice of many things we wanted but in the end what we really wanted was to be free from our debt!

Step 1. The first and most important step to getting out of debt is this: Admit you have a problem.

I cannot stress this point enough - changing your behavior is the key to eliminating debt. After you recognize your situation, you next need to assess the severity. This leads to step 2.

Step 2. Find out where your money is going.

The next step is to create a budget. Many people never make it beyond this step. This is mostly because they set unattainable goals by making idealistic assumptions about their cash flow. They forget to account for all the "little things" like their daily coffee from Starbucks or a bottle of wine once or twice a week. It is true that these things are little on there own, but in the aggregate they add up and they can make the difference of being on target or $100 over budget for the month.

You don't necessarily have to stick to a strict budget for spending, but you should create a budget for a few months to see where your money is going at the very least. This is what we did. Once we got an honest handle on where our money was going, we were able to find places we could trim our spending. Which leads to step 3.

Step 3. Cut expenses where you can to free up money.

This step is all about freeing up extra money that can be put toward paying down your debt. Take a close look at your budget and see what expenses you can cut. Be sure to ignore any debt payments, i.e. Credit card payments, car loans, mortgage. You read correctly: ignore those payments, for now.

Shop around for new car insurance and increase the deductible to lessen the premium. If you have high long distance bills, consider consolidating your cable, Internet and phone service or go without cable for a few months if you want to eliminate your debt even quicker. If you need a cell phone, but never use all your minutes, you may also want to look into a pay as you go service.

Bill consolidation and elimination is a major part of this step. Look at your budget and cash flow and eliminate (or reduce) any reoccurring payments that you can. These can act like financial wounds that slowly bleed your bank account dry.

Step 4. Consolidate any loans that don't carry tax-deductible interest payments.

This is an extension of Step 3. Where Step 3 dealt with cash flow for non-debt payments, Step 4 focuses the same approach on debt payments. Now, go back through your budget and look closely at all your debt payments - the ones I said to ignore in Step 3. It's now time to focus on debt consolidation.

Look for items like car payments, personal loans and credit card debt. If you own a home, consider transferring your balances to a home equity line of credit for a lower rate as well as a tax deduction on the interest paid. You can also consolidate to 0% (or at the least a lower rate) card with a balance transfer offer to another credit card. NOTE: This is only beneficial if you already have the credit card (i.e.: don't take out any more credit cards) AND if you stop increasing your credit card balance. This goes back to Step 1. I've seen too many people consolidate their credit debt on a 0% transfer and then go on using the 1st card without paying off the transfer, only to see that 0% introductory rate jump to double digits over night.

Finally, if you have student loans I highly recommend looking into federal loan consolidation services, or student loan consolidation services. It's possible to refinance multiple student loans into a single low interest (sometimes less than 3%) loan.

Now that we've taken stock of the situation, it's time to develop a plan for downsizing your debt.

Step 5. Eliminate unsecured debt.

Pay down high rate, unsecured debt first. This is mostly credit card debt. You'll pay more in interest than you could make in a savings account and there are no tax benefits; so get rid of this debt first. A general rule of thumb is to pay at least twice the minimum monthly payment, with any extra cash also going toward this debt.

Step 6. Cleanup the secured debt.

Next, pay down any car loans you might have followed by student loans. Rates were very low for government-backed loans a few years ago, so it's possible you have a rate in the range of 1-3%. If this is your situation, then you're probably best off with paying the minimum, getting the interest tax deduction and putting any extra money in a high yield savings account.

Step 7. Buy only when you can afford to and never pay full price.

Budget and save before you buy. Try to buy only when items go on sale. This can range from groceries to mp3 players. Be patient and pay with cash instead of credit. You'll be surprised how soon your thinking will change to saving instead of spending money, and you'll be glad it did.

Changing our behavior is never easy, but the rewards can be tremendous. In the case of learning to live debt free, you'll find a new sense of confidence and security. You'll also be on the road to building true wealth and having your money work for you, instead of working for someone else.

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