Being debt-free is one of the best feelings in the world. I remember the excitement that Vanessa and I felt after submitting our last payment toward our student loan debt. It was such a liberating moment in our life. I want blog readers to feel that same joy and freedom, which is why I have put together this guide on getting out of debt quickly.
Vanessa and I both hope that this post will help you become debt-free a little bit sooner. It can be a tedious process, but being debt-free is worth every effort required.
1) Ask yourself: Why?
The first step in eliminating debt is figuring out the motivation behind the action. ask yourself the following:
- Why are you in debt in the first place?
- Why do you want to become debt-free?
Without a clear motivation for your plan, your habits will not change, and your financial success will likely be limited.
For us, the motivation is financial freedom.
What is your reason, and why do you care?
These motivating factors are of the utmost importance when discussing debt. If you don’t have the internal motivation, you probably won’t make any real, lasting changes in your financial life (i.e. change the behaviors that got you into debt in the first place).
2) How much do you owe?
In developing a plan to repay your debts, you must know the total amount owed.
When collecting this information, you should attempt to find the following pieces of information:
- The type of debt
- The amount of each debt
- The interest rate on each debt
- The minimum monthly payment required
Call or email each company and get all of the facts.
You can store this in a simple Excel file, or you can use a free Excel calculator (which I’ll describe later in this article).
3) Automate minimum payments
To begin the debt repayment process, you should create a system that automatically pays the minimum amount due on each of your debts.
The easiest way to do this would be to create a recurring transfer from your bank account. For example, Discover Bank allows free ACH bill payments and you can schedule recurring transfers.
Creating this system does several things for you:
- Lessens the mental math required each month. You don’t have to think about each payment.
- Removes the possibility of late payment penalties.
- Improves your credit score each month.
Once created, store the minimum required payment amount for each debt in your Excel sheet. This will help you remember things at a later date.
4) Track your cash flows
Now that you are paying the minimum required amount each month, it’s time to formulate a plan for paying down that debt quicker.
The first step of accelerated debt repayment is figuring out how much money you have available each month. The easiest way to accomplish that is by setting up an account at Personal Capital, where you can track your income and expenses for free. You simply link your financial accounts, and it records all of your transactions. If that isn’t working for you, you can make a budget and track everything on an Excel sheet. It is more work, but some people prefer the traditional budgeting process.
The method isn’t that important. What matters is tracking your income and expenses so that you know how much money is available. Armed with this information, you might be able to reduce your expenses each month, creating additional income that can be used to accelerate your debt repayment schedule.
5) Create an emergency fund
An emergency fund is a cash reserve, often set aside in a checking or savings account. Having some money set aside is crucial, because it prevents you from falling further in debt if an emergency occurs.
$1,000 is a good place to start, but feel free to choose a number that suits your financial situation.
6) Destroy Your Debt
If you have several different types of debt, with each carrying a different interest rate, how do you decide which debt to pay off first?
Well, you have two options:
- Debt Avalanche – Pay your highest interest rate debt first. When that’s eliminated, tackle the next highest interest rate debt.
- Debt Snowball – Pay your smallest debt first. When that’s eliminated, tackle the next smallest debt.
From a rational perspective, the debt avalanche method always makes more sense. By paying off your highest interest rate debt first, you minimize the amount of interest paid across all debts.
From a behavioral perspective, the snowball method can make sense. You will pay more interest each month during the repayment process, but the motivation provided by paying off those smaller debts encourages you to keep going.
It’s also possible to combine the two approaches. For example:
- Continue paying the minimum amount required on all debts.
- Make larger payments toward any debts that could be eliminated in a short period time (define short however you would like. For example, 6 months).
- After eliminating all your small debts (providing additional motivation to continue), shift your focus toward the debt with the highest interest rate.
- Continue paying off the highest interest rate debt, one by one.
Consider using a debt repayment calculator
There are some excellent free calculators available to help you decide between the debt avalanche, debt snowball, and other custom repayment methods.
When you download the Vertex Excel calculator that I’ve linked above, notice the various features that are available. You can input each debt, the interest rate, required minimum payment, etc. In my example, I have four debts listed. The total debt is $19,800 and the total required minimum monthly payment is $290 per month.
This calculator allows you to specify your preferred payment method and the total monthly payment amount. When tracking your income and expenses, you can determine the appropriate total dollar amount that you can afford to put towards repaying your debt. I’ve specified a total monthly payment of $450. Given the $290 required minimum payment, there is $160 available to put toward the snowball method or avalanche method.
To compare your repayment options, you can select debt snowball, debt avalanche, or a customized method created by you. By switching between each repayment method, you can visually see the total interest paid, and the date of repayment for each debt.
If I choose the debt snowball method of repayment (paying the lowest balance first), you can see that I will pay $6,032.70 in total interest. The final debt will be repaid in September of 2021.
If I select the debt avalanche method of repayment (paying the highest interest rate first), you can see that I will pay $4,765.77 in total interest. The final debt will be repaid in June of 2021.
If I’m able to find an additional $100/month to put towards repayment, the total interest paid decreases to $3,589.08 using the avalanche method. Furthermore, the final debt is repaid an entire year earlier – in June of 2020.
This difference in total interest paid highlights the difference between choosing the rational method (avalanche) and the behavioral method (snowball). What’s also interesting to note is that the avalanche method will almost always shorten the amount of time required to become debt free.
Becoming debt-free is the ultimate goal here, so choose the method that will keep you motivated to destroy your debt.
7) Revisit your spending habits
With a plan in place, you should continually monitor your income and expenses. In doing so, you can begin making changes that will increase your available cash flow, enabling you to make bigger payments toward your debt. Bigger debt payments will reduce the time it takes to become debt-free, and reduce the amount of interest paid on each debt.
Sometimes cutting expenses is the easiest way to begin. Here are some ideas that can help get you started:
While you are cutting expenses, you can also begin thinking about ways to increase your income:
- Sell extras on Craigslist
- Negotiate a higher wage at your job
- Begin searching for a higher paying job
- Start a business on the side (for example, a blog)
8) Share your story
Becoming debt-free is much easier if you have a support group encouraging you. Being able to share the trials and triumphs is a crucial part of the process.
Maybe you can share your debt repayment plan with family or close friends. Sharing your journey will also allow you to suggest cheaper entertainment options, such as potluck dinners and Amazon Prime movies at home.
If you are currently working on paying off your debt, please leave a comment below. We would love to hear about your progress.