Getting out of debt; Staying out of debt
If you're in debt, you're in good company. In the U.S. there are a lot of people carrying a staggering amount of credit card debt. And, we also have to remember the debt carried by our governments as well. Obviously since being in debt is a burden that diminishes your life, it would be good and useful to get out of debt and stay out. So let's go over a few strategies and ideas that I've gleaned in my travails with debt.
An important first step is to take stock of your real situation. How much money are you bringing in? What is your available cash after necessary expenses? How can you trim your necessary expenses? Are you able to keep up with the necessary expenses, or are you just digging a deeper hole? Is your spending in control, or outta control? Do you even have any clue how to answer any of these questions?
Obviously if you're going to solve the problem, you have to understand what the problem is. If your spending is out of control and you don't know it, then how can you change? Or if you don't realize you're just falling behind every month and have no chance of ever being able to keep up, then what?
A good method of taking stock is to use a program like Quicken or Money Dance, or even a well constructed spreadsheet. You enter every expenditure categorizing everything correctly. After a couple months you'll be able to see where it's going, especially with the reporting tools the personal finance software have built in.
Watch out for the flash-in-the-pan strategies
I was once in debt for $4,000 or so and got scared. Being scared I went into high gear, really focussed on debt payment, and paid it off pretty quickly.
But, I did not change any of my habits. I merely got focussed on paying debt. So is it a surprise, then, that a few years later I had a credit card debt again and that it was 10 times higher?
It is best that you strategize not just paying the current debt, but how can you make a long-term turnaround. What changes in your overall lifestyle and habits will contribute to always staying out of debt? Do you want to recreate this same problem later? If not, then look at your habits and change them.
Pay much more than the minimum payment
Every month you carry a debt, you are charged interest on the balance. The higher the balance the higher the interest.
Obviously, then, the more quickly you pay the debt, the fewer months you carry the balance, and the fewer months you're paying interest on the debt.
Your ability to pay much more than the minimum payment is directly determined by your available cash.
The snowball method
There are many possible strategies for paying credit cards. The strategies revolve around the questions of which card to pay first, and how much to pay each card.
Among those methods there is one method which, mathematically, is the fastest route to becoming debt-free: The Snowball Method.
- In a table, list all your debts as creditor name, current balance, interest rate.
- Each month you pay the minimum payment on every debt, except for the one with the highest interest rate.
- The debt with the highest interest rate is the one you're currently attacking, and you put all the money you can into paying that debt.
What happens is that, as you clear off the high interest rate debt your ability to pay the debt grows (less money is going to interest charges). Hence "snowball" because your ability to pay debt is like a snowball rolling downhill getting larger and larger.
Obviously you need to recreate this table every month. As you pay off the debt with the highest interest rate, a new debt will become the next target.
Decreasing expenses; LBYM
As covered elsewhere, if you make sure to keep your expenses well below your income then you've got an extra stream of cash to put to other uses. Such as paying off your credit cards. The more available cash you have, the more quickly you can pay off the cards, and the less this experience is going to cost you.
If the debt situation is really dire, you could think about staying in emergency mode until you get out of debt. Pare your expenses to the minimum, learn how to enjoy peanut butter sandwiches, and all the rest. But by all means, if you can at all afford it, treat yourself to something every so often because otherwise it can be a long haul getting out of debt while keeping expenses slashed to the bone.
Decreasing interest cost
A balance carried at 25% obviously costs a lot more in interest than a balance carried at 5%.
One way to end up with 25% interest rates is to forget to pay your monthly bill a few times. The credit card companies tend to have rules saying that if you're late in paying they will jack up your rates into the stratosphere. When you're late with a payment that's usually a sign of impending deliquency, and as a potential bad credit risk your rates are always going to be higher than if you're a good credit risk. In any case, it is a preventative measure to ensure you pay at least the minimum payment on every card every month. If you already have a stratospheric rate, and have had some late payments, if you establish a record of paying on time for a few months the card company may relent and lower your rates.
You may get offers in the mail for balance transfers at special interest rates. As discussed here, be sure to carefully understand the rules surrounding the balance transfer offer. There are many ways to screw up on a balance transfer plan and end up worse off than before.
You can call up the credit card company and request a lower interest rate. I was shocked and surprised when I first heard of this, but it really works. The credit card company isn't going to do this every time, for whatever reasons they have of their own. You can always ask to speak to a supervisor if the first response is "NO". One type of bargaining chip is to threaten to transfer your balance to another company.
Begin paying your new expenditures in full every month
This falls into the category of establishing good practices. Obviously while you're in debt you're going to have new spending. How you handle the new spending is a great way to establish new and healthy habits, or to reinforce the unhealthy habits that got you into the problem in the first place.
Questioning what you're buying, and why
This also falls into the category of establishing good practices. If you're like me, your spending may be happening without conscious thought process. You might see something, have an idea you "need it", and buy it. And then the house fills up with stuff, your credit card balance skyrockets, and pretty soon you're looking for web pages like this one wondering how to get out of debt.
Stop and think about expenses. If you find yourself in the store clutching a Mini-Disc player, and you can't think of why you really want one or what positive use it would have, then perhaps you have a problem? Increasing your level of awareness as to why you buy stuff, when you buy stuff, what are your reasons, all this will go a long way towards resolving the spending habits.
If you're serious about staying out of debt, establishing good habits is essential. This, your spending habits, is one area to pay extra special attention.
Rooting out "fees"
There are a number of fees that can kick in, and make your available cash situation worse. Every fee decreases available cash, and in dire credit situations every penny you can squeeze out is vital.
For example it's likely that your bank balances are going to be low. Your bank may charge fees for having a low balance. Obviously to avoid this you must keep the balance high enough. The downside is that the money required to avoid fees is then trapped in your account.
Do you understand what use "credit insurance" is? Well, neither do I. But it's an extra charge the credit card company may puts on, if you have this insurance. If you don't see any use to it, then call them up and cancel the insurance.
Do you really need that collection of Chia Pets? How much money would they be worth on eBay?
In other words, lying around the house you might have some assets that could be turned into cash. Think about selling them and getting that cash. You can also donate them to charity, and take the tax deduction, increasing the income tax return you'll get next April. If you donate hard items to charity, learn what the rules are before you do so as you may have to get the thing appraised if its value is high enough.
DO NOT RAID THE IRA OR 401K
While it may be tempting to raid the IRA to get the money to pay your debts, stop now and think about another plan. Take a careful look at the costs involved with withdrawing money from your IRA before retirement age. There are large fees and it will increase your income, and therefore raise your taxes. You probably don't want to pay these costs, no matter how desparate your debt situation may be.
If you take a loan from your 401K plan, what happens to the loan if you have to switch jobs. The 401K plan is tied to your specific employer, and you generally have to pay it off if you switch jobs.
Finally there is the opportunity cost. You went to a lot of trouble getting that money into the tax-sheltered situation. You spent a lot of your life earning the money in that account. Is this the best use of that effort?
Declaring bankruptcy seems like the easy way out. Many people take this route every year, but let me try and dissuade you.
The first consideration is, what will you learn by taking the easy route? If you got into debt because of bad habits, how are you going to break those bad habits? How likely are you to end up back in debt trouble again, and maybe its 10 times worse this time? (like it was for me)
Next is the massive effect on your credit rating. After bankruptcy it takes several years to get going again with having a credit rating and any ability to have a credit card. What impact will this be on your life? Will you lose your house?
Finally, think of the moral obligation. You spent the money represented by that debt, and when you did you entered into an obligation to pay the debt off. By declaring bankruptcy you are in effect making the rest of us pay your debts. As someone who paid off his own debts, even when the situation looked bleak and impossible, let me tell you this: Your situation is probably not as impossible as it seems.
Staying out of debt
Staying out of debt is done by having good practices. The practices you develop while in debt, that you use to pay off the debt, often can help you stay out of debt.
The transition point of going from debtor status to non-debtor is an important one. While in debt your habits and thinking pattern tend to revolve around the struggles of being in debt, such as hunting up the next balance transfer. Before you recreate your debt just to feel comfortable again, stop and realize the world is different when you're not in debt. You don't have to scramble around finding new balance transfer plans, you're out of debt, and you're going to stay out of debt. This is going to take a different set of habits and thinking patterns.