How to become debt-free

How to Become Debt-Free

1) Become disgusted

This is by far the most important aspect of becoming debt free. You have to really want to get out of debt! Becoming debt-fee is not a luxury. It’s mandatory! And if you believe otherwise, I wouldn’t even bother wasting your time trying to get out of debt.

Mad faceYou have to get disgusted about debt. You have to get disgusted that you work 40+ hours a week but don’t have any money to show for it. You have to get disgusted that money is so tight that a simple car repair turns you into the Incredible Sulk (see what I did there?). You have to get disgusted that “retirement” is just another financial burden. You have to get disgusted that you allow peers to dictate what’s normal in your life. You have to get disgusted you asked friends or family to loan you money. You have to get disgusted that people in much worse financial conditions have become debt-free much quicker than you.

I suggest you work towards becoming debt-free only when you are truly ready to once and for all say good-bye to debt. Do not try this half-heartedly. The rest of the steps are worthless without a total change in mindset. “Kind of doing it” is worse than not doing it at all! Getting out of debt is not going to be fun! And it shouldn’t! You already had your fun – that’s why you’re in debt!

You cannot easily get out of debt! It takes an all-out “I’M SICK AND TIRED OF BEING SICK AND TIRED” attitude. All of you energy is goes toward eliminating debt!

You don’t shop! You don’t eat out! You don’t go on vacation! You sacrifice all you can TEMPORARILY so that you one day you can shop, go out to eat, and go on vacation…AND ACTUALLY ENJOY YOURSELF! And actually continue to make progress towards a fulfilling life while continuing to shop, eat out, and vacation! This can’t be done until you are debt-free. It’s either-or up until that point.

Regardless of which debt reduction strategy you use, regardless of your starting point, the key to success is your attitude. It’s not going to be easy, but it’s going to be worth it! You’re not only becoming debt free, you’re changing your life!

2) Create a Budget

Budgeting 1I suggest you create and follow a budget if you’re broke, a millionaire or a billionaire. I suggest You have to create a budget if you want to become debt-free! The first step in reducing the amount of money you owe is to identify how much money you have. Following a budget allows you to build margin into your life. Margin you will need to pay off debts and keep your lights on.

You will be amazed at how much money you “find” when you put all income and all expenses on paper (A.K.A. “a budget”). You will start to save and accumulate money that used to disappear by doing nothing else besides following a budget. Imagine how much money you could find if you followed a budget and wanted to become debt-free.

Cick here for more information on budgeting!

3) Save $1,000 (or empty your bank account to health insurance deductible if…)

If you are familiar with Dave Ramsey’s Baby Steps, you know Baby Step 1 is saving for a $1,000 baby emergency fund. Anything over that is put towards debt (Baby Step 2)! As long as you have $1,000 in the bank, you do not do any additional savings. Every dollar you make over $1,000 goes to paying for shelter, food, transportation, clothes and debts.

Broken piggy bankI think this is great advice and should be followed. But others, especially in debt, are too frightened to write a $29,000 check when they have $30,000 in savings and $50,000 in debt. If that paralyzes you, I like to give one other option besides the mandatory $1,000. This is the only modification I would make to the baby steps…

If you have more than $20,000 in liquid cash (and for some reason not paying off your debts), I would put all of it towards debt EXCEPT for the amount of your health insurance deductible assuming all members of your family were to need healthcare.

If you have less than $20,000 of liquid cash in savings, I would write a check for everything but $1,000 to pay off your debts. Just like Dave Ramsey prescribes. Unlike those with more than $20,000, you shouldn’t have a choice. Opting for the deductible amount instead of $1,000 could ultimately mean you use less than half of your savings to pay off debts. At this point, it requires too much thought and not enough action to not use your savings towards paying off debts.

Why the $20,000 cutoff? Well, if you’re below this amount it probably doesn’t matter what kind of emergency you have – it will still be an emergency! The best thing you can do while in this position is getting out of debt quickly! And pray all emergencies are temporarily postponed!

If you’re above this amount, you have (and I don’t know why) saved quite a bit of money but haven’t done anything about your debt. Emptying your savings to a lousy $1,000 is something most people are not okay with! So much so they will decide to do nothing! Just stay in debt and have the “peace of mind” (that’s an oxymoron if I’ve ever heard of one) of having money in the bank.

I hope this advice will smooth over the polarizing idea of what to do with your savings when trying to get out of debt. Hopefully each of you can pay off your debt in one sitting. But for most, it’s going to take a lot of small steps to get you to your destination. Don’t let fear keep from taking that first step. When in doubt, follow Dave Ramsey’s Baby Steps exactly. I’m just trying to eliminate any excuses people may have.

4) Stop adding to your debt

stop signI’m not a mathematician but adding to something you are trying to subtract from doesn’t make much sense. It might seem this is good advice strictly from a math perspective. But this is only part of the reason.

The main benefit of not adding any more debt is behavioral modification. You have to feel what it’s like to not use debt (or even credit cards) for an extended period of time. It will be very tempting to reach for a debt card (not to be confused with the Debit Card) while working through the Debt Snowball. You will not have much discretionary income during this time because most of it is going towards the debt. But once you become debt free, you will see that it is possible to live debt free AND you will have more discretionary income (you are no longer paying off debts)!

Not only should you not add any more debt, I would highly suggest you don’t buy anything “big” unless you absolutely have to. No house (rent if you don’t have a place to stay). No furniture. No vacations. No [insert any indulgence you want].

The only purchase I can envision you would “need” to make would be a car if yours was rendered useless. As in it literally doesn’t start. In that case, I think it would be a good idea to get another car in order to drive to work. You like that part? Here’s the part you’re going to hate: A nice car, under these circumstances, will cost you less than $3,000. But why would you need a nice car now? That’s for later when you’re debt-free. So find a car less than $2,000!

5) Stop investing into retirement

investing streetPeople hate this with a passion! Most financial wizards label this as “terrible advice”. If you’re not convinced this is good advice, read Stop Investing!? Do you still think its bad advice? Fine – I tried my best to persuade you why this is the best long-term strategy towards financial freedom and failed.

Here is a simple question to illustrate my conviction that there is no room to invest AND get out of debt: If you were magically debt-free but did not have any money to invest, would you go to the bank and take out a personal loan to invest into an IRA?

I hope the answer is a quick “NO”. So what’s the difference? You are investing with borrowed money!

If you would do this, I don’t think we will ever come to an agreement regarding financial matters. I don’t care what the return is! Financial wizards might argue you could “net” a positive return (i.e. 10% return from an IRA would be offset by a 6% interest rate; thus, you earned 4%).

What about, oh I don’t know – RISK!? 100% of all bankruptcy’s involved borrowed money. 100% of bankruptcies are stressful (if you are a person of integrity). Getting out of debt is your first priority. And it needs to happen as fast as possible. The money you once invested is stopped – temporarily – and put towards paying off your debts. Then, after your debts are paid, you can begin to invest more than you ever have AND with less risk!

If you said “yes” are you guaranteed to go bankrupt, live a terrible life or turn into a murderer? No. But why take such large risk for such small reward. There are more reliable and less risky ways to get the same return.

6) Use the debt snowball

[Why I suggest using the Debt Snowball method]

snowballThe Debt Snowball Method is a debt reduction strategy, whereby one who owes on more than one account pays off the smallest balance first while paying the minimum on larger debts. Once the smallest debt is paid off, one proceeds to the next smallest debt above that, and so on and so forth, gradually proceeding to the larger ones.

The Debt Snowball gets its name from the fact that, over time, the debt repayments get larger and larger – like pushing a snowball down a hill! Once the first debt is paid off, the amount of your monthly repayment gets rolled into the second largest debt. The second debt will be repaid in the amount of your first debt PLUS the minimum payment of the second debt PLUS any extra money you find. The third largest debt will be repaid in the amount of your first debt PLUS your second debt PLUS the minimum payment on the third debt PLUS any extra money you find. And so on.

By the time you get to the third debt, your monthly repayment will be much larger than the minimum you were paying when you first began the Snowball. Even if you don’t contribute any more money! It takes an extra push at the beginning, but your debts will be kicked out of your life faster and faster as the snowball picks up speed.

The Debt Snowball is quite simple – it just requires patience, accountability, and the ability to delay gratification. Ironically, these are three virtues that distinguish a child from an adult.

There are 5 steps to complete the Debt Snowball:

Step 1: List all your debts with total amount owed and minimum monthly payment

List Your DebtsList EVERY debt you owe, including debts to friends and family. The only debt that is allowed to be left off is your mortgage.

You must include the total amount owed and the minimum monthly payment to start the Debt Snowball. I would also include the interest rate, but only because it will be important in giving you a realistic time frame you can expect to become debt free.

THE INTEREST RATE DOES NOT FACTOR INTO THE DEBT SNOWBALL. If you were worried about interest, you wouldn’t be in debt. You can’t start worrying about it now!

Step 2: Pay the minimum payment on every debt except the smallest debt on your list

This may seem counterintuitive, but any extra money you find during your Debt Snowball goes ONLY to the smallest remaining debt. It does not help to focus on more than one debt at a time!

Ensure that you are making the appropriate monthly payment on the second smallest and above debts. Other than that, forget that it exists. All your energy should be on the smallest one. The bigger debts will come in due time! Stay the course and let the Snowball do all the heavy lifting for you.

Step 3: Determine how much money can be put towards your initial Debt Snowball

The initial Debt Snowball will be the minimum payment of your smallest debt PLUS any extra money you can put towards your debt. Just putting an extra $200 towards your initial snowball can reduce the time before your debt free by YEARS for some people.

Find as much extra money as you can to start you Debt Snowball. Finding an extra $100+ should be extremely easy if you create a budget and truly want to become debt free. You might have to forego pizza and happy hour a few times, but you I know you can find $100 or $200 dollars to spare.

Step 4: Keep finding money

find moneyIt’s always possible to find more money. What should be reassuring is the fact that you only have to find money during your Debt Snowball. Once it’s done, and you are debt-free, the money will find you!

Is it taking too long to get out of debt? Are you disappointed in how long you are going to have to sacrifice?

Sell something! Then sell something again! And again! Work overtime! Become a taxi driver! Cut someone’s grass! Do whatever you need to do! This is only as temporary as you make it!

Step 5: Stay the course

Getting out of debt is going to bring about a lot of emotions. At first, you will be excited and can only think about all the good that will come when you no longer work to pay someone else. But reality is sure to set in shortly after the honeymoon phase! It will not be easy or enjoyable. There will be times when you want to quit. Or simply just believe it’s impossible.

Just stay the course. Keep plugging away one month at a time. This is not a sprint – it’s a marathon.

Find ways to stay motivated. Tape notes around your house. Tell your friends and family the agony you’re going through, but more importantly tell them WHY you are doing it! Because it’s easy to forget in the midst of a treacherous journey!

[Example of the Debt Snowball in action]

7) Build wealth

  1. Emergency Fund
  2. Invest
  3. Save for college, increase giving, increase spending, and pay off mortgage

opportunityAt this point you should be completely debt free (except house mortgage). This is the time when you decide which life you are going to live. Are you going to stay debt-free? Or are you going to relapse into debt?

Have you ever watched The Biggest Loser? Week after week contestants lose significant amounts of weight. Like, significant! Many winners lose well over 100lbs in their quest to become The Biggest Loser. At the end of each show a contestant is either voted off by their peers or voted off based on their weight loss for that week (“below the red line”). After they reveal who will be leaving the show, we are shown a small clip of the present day to see how that particular contestant has been doing since the time between the airing of the show and present day. Sometimes they look amazing! They really kicked butt without the cameras! But other times, well, they’re back to their original weight to put it nicely.

It’s such a popular show because we are amazed at how life-changing this journey is for the contestants! But that’s not what we are really impressed with. Every time we see a contestant at the finale who has gained all their weight back we think, “ohhhh…”! Like as if that’s more polite way to say, “Yeah, I figured she would gain it back.” We are impressed when contestants change their life permanently, not just while on a show that tells them exactly what to do and when to do it. Sure, it’s not easy to lose a lot of weight. But it’s really not easy to lose a lot of weight AND keep it off!

The Biggest Loser is a lot like when someone is trying to pay off their debt. They want to lose a lot of weight (debt) that was destroying their lives. They want to lose it fast! And there is a great reward at the end – they get money and their life back!

Losing a lot of weight or paying off a lot of debt is impressive. But adjusting your lifestyle permanently to make certain destructive habits don’t creep back into your life is really impressive.

Building wealth is the tool used to ensure you continue to live a debt-free lifestyle. Emergencies are no longer an excuse to pull out a credit card. You’ve already planned for it! The ultimate goal is to have enough financial margins where we can stir essentials, fun, emergencies, and no stress into one huge melting pot called “Life”.

Money growingBuilding wealth doesn’t stop there! It gets more and more fun as we go along! Imagine building enough wealth where donating $10,000 to pay for a child’s medical bills –a child that you don’t even know – is just a drop in the bucket. Imagine going on an once-in-a-lifetime vacation with your entire family, in-laws and grandkids included, and paying for the whole thing. Imagine getting that dream house that only “those” people could afford.

These are all real possibilities for anyone willing to keep a job! And notice I didn’t say a well-paying job! Building a substantial amount of wealth over time to spend and give is predicated on consistently earning an income, investing in easily understandable mutual or index funds, and staying away from debt!

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