How to Get Out of Debt: A Step by Step Guide

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Most people are struggling to pay their debts, which on average exceed $38,000 per person (excluding mortgage debt). Despite increasing awareness of the subject, the total amount of debt keeps on increasing every year. For many Americans, it has become a crisis as they can’t find a way to get out of the mess.

According to a recent survey by Northwestern Mutual, one out of five American spends 50% to 100% of their monthly income repaying debt. It is also true that this mounting pile of debt has decreased quality of living forcing many Americans to face a miserable life. As families continue to struggle, debts on credit cards, student loan, car loan, and mortgage are shaping into a never-ending juggernaut destroying the nation.

Unfortunately, the monster continues to consume Americans as they grow older. Debts start as early as college years as students aged between 18 and 24 carry an average debt of $22,000. Accordingly, the student loan amounts to 28 percent of the liabilities for this age group.

As Americans get older the nature of their debt changes but the amount they owe continues to increase. The total debt grows to $42,000 for Americans between 24 and 34 years; however, credit card becomes the leading source of debt, for this age group. As some of the debt is paid off, home mortgage takes over as the primary source of debt for adults who are over 34 years of age. The end result is an American who doesn’t have any savings left to enjoy life in the retirement years.

It will not be an overstatement to suggest that the endless cycle of debt is consuming the lives of Americans. So, what you should do to start living normally? Here is a step-by-step guide on how to get out of debt quickly, and start living the life you always dreamed of.

Best Way to Pay off Debt

Let’s face it; there is no quick-fix solution to pay off your debt in a very short time. Be cautious of swindlers who claim to help pay your debt, instantly. While there are no shortcuts, if you follow these simple rules, you’ll be on your way to a debt free life.

In the first phase, get yourself organized by understanding the total amount of your debts. Get a pen and a paper to review ramifications of your loan on your total budget. Getting organized will not only help you realize the enormity of the situation, but it also helps with planning how you can get things fixed, quickly.

The next stage is to sketch out a plan on how you’re going to lower your interest rates and make changes to your lifestyle to save yourself. It includes such things as creating a budget, lowering your interest rates, and making lifestyle changes to pay off debt faster.

In the final stage, select the best route that will help you reach your debt free goal in the shortest possible time. Besides comparing the debt payoff methods of the debt avalanche and debt snowball, the final planning stage includes setting up a fund to control debts during emergencies. For a blueprint of how to do it, follow these steps:

Step 1: Calculate how much debt you owe?

Do you really know how much debt you owe? Most consumers don’t realize that calculating your debt may not be as simple as pulling out relevant payment receipts from various lenders. In fact, the best place to start looking for the balance is to pull your credit reports.

In the United States, there are three major credit bureaus, Equifax, Experian, and TransUnion. Get credit reports from all these three agencies because some lenders only report to one or two credit bureaus. These reports usually have all the information about your pending credit card bills, mortgage, student loan, car loan, and any other borrowings.

Since each credit statement has specific cut-off dates for payments, it is likely that you will also need to compare your credit card statements to reconfirm your loans because credit card statements are updated regularly. Evaluating credit reports is as easy as looking at the balance of your credit card, and comparing it with the outstanding loans on credit reports.

If you are still unable to get a clear picture, it always helps to call your creditors to understand any credit anomalies. It is also not uncommon to see an error on a credit report, which can occur frequently. Therefore, it makes sense to get the entire picture and dispute any errors on credit reports.

Step 2: Lower your interest rates – Reduce your monthly payments

Once you get the hang of your total debt, pick up the phone to talk to your credit card company on the prospect of lowering your interest rate. On average, rewards cards charge an interest rate of 15.99% APR, and 20.90% on cash back cards. Accordingly, it makes a lot of sense to lower the credit card rate because reducing it by even 1% can make a difference of hundreds of dollars.

If you are a loyal customer who makes regular monthly payments, you may convince your credit card company. Similarly, if you have a good credit score, calling the credit card company also makes a lot of sense. In contrast, you may find it very difficult to convince credit card companies to lower the interest rate, if you are a new customer, or you miss payment deadlines.

To tackle the problem, search for competing credit card offers from other companies. Due to the competition in the industry, a lot of credit card companies try to attract customers by offering lower rates. Make a list of such offers, and politely provide the information to the customer service representative of your own credit card company. The trick usually works. If it doesn’t, it may be better to take an alternate offer from another credit card company just for the sake of lowering your debt.

Step 3: Create a Budget

After you have an idea of the total debt, it’s time to think about your income and expenses. If you get regular monthly payments, it is easier to estimate the income. In contrast, irregular income can prove difficult to estimate as businessmen often face good and bad times. As a rule of thumb, income should be based on the minimum amount you earned in the last six months.

If this also seems complicated, just think about a rough figure that you can easily earn every month. It is important not to over-estimate the income because it can affect your ability to pay the debt. Over-estimation can also disrupt any blueprint you have created to get rid of the budget.

Similarly, don’t overlook expenses. There is always a tendency to pretend that you are spending less on items that make up the bulk of expenses. Therefore, always acknowledge that expenses are part of your daily routine, and there is no getting away from the reality. In short, try to estimate your expenses, properly.

The end result will be a realistic estimation of the debt, income, and expenses. At least, you can be proud of yourself of taking the critical step to success by understanding your financial position, which most of us continue to ignore.

Step 4: Make changes to pay off debt faster

After you have a clear picture of the financials, it is easier to decide what changes you can make to your existing lifestyle. Making extra money and not making lifestyle changes is enough for some.  For others, you may look to cut expenses or even sell some of your extra things.

Make Extra Money

The easiest method to pay off debt is to start making extra money. There are several ways to make extra money, some of which you can start today.

Start today:

  • Make some extra cash by taking online paid online surveys.  Read our best-paid survey sites to start making money today.
  • Offer a freelance service.
  • Rent out a spare room or your entire apartment through Airbnb.

Try getting innovative, and you will probably find something to earn that extra money.

Assuming you work eight hours a day, even one extra hour can bring you a lot closer to financial freedom. At 10 dollars an hour, if you can work an extra hour for 5 days a week, then you will make at least $50 every week that can turn into $200 a month. If your workplace doesn’t provide you with the opportunity, then try to take a second part-time job.

Start as soon as you can:

  • Pick up extra hours at work if you work hourly.
  • Get a second job.

Cut Expenses

Did you know that housing, food, entertainment, and transportation make up four major expenses of an average American? Therefore, if you are serious about cutting costs, controlling housing costs should be the top priority. Experts suggest that trimming 10% from housing expense can save more than $1,700 per year for an average American. It means that moving to a smaller space can help you. Similarly, if you are living in a big city, selling your car, and using public transportation can also heal problems, quickly. In fact, you can easily buy another car once your debts are controlled.

Sell things you own

Who doesn’t like some extra cash? If you have stuff that you rarely use, sell it to the market. Just go on the Internet, and you will come across a variety of online yard-sale markets that buy everything from used clothes to antiques and old computers. You can even hold a yard sale or advertise your stuff on a notice board if you live in an apartment. Even a couple of hundred dollars will go a long way in reaching your goals.

Step 5 – Which debt to pay first?

Once you’re ready to make changes to your lifestyle, it’s time to decide the debt that you must pay first. The following two methods can help you in the decision-making process:

Debt Avalanche

Debt Avalanche is a simple process, which encourages you to pay the minimum amount on each debt, every month. Once the minimum is paid, whatever remaining money you have is used to pay the debt that has the highest interest rate. This method is designed to pay off the debt with the highest interest rate first.  The benefit of doing this is you will pay the least amount of money in interest in your debt payoff journey.

Debt Snowball

Debt snowball works opposite to the debt avalanche. It starts with paying the maximum you can to the loan with the smallest balance, while still paying the minimum on your remaining debts.  The debt snowball strategy is designed to give you quicker wins by paying off small balances first.  Once you pay off one balance, you roll the amount you were paying there towards the next smallest loan balance.  And this is how the strategy gets the name of the debt snowball.

On your path to get out of debt there is not a much better feeling than to completely pay off a loan.  With each debt that you pay off, you build momentum that encourages you to keep going.

Between the 2 methods, I will always go for the debt snowball method.  Getting quick wins in paying off the smallest debt balances first gives me the motivation to continue.

Step 6 – Create an emergency fund

A good debt payoff plan is risky without setting aside funds for an emergency. To understand the importance of an emergency fund, think about a scenario where you would suddenly have a substantial expense.

  • Unexpected car repair
  • Medical bills
  • Roof leak or other urgent house repairs

Even if you are going according to a set plan, unexpected events can rack up additional debt.

It is smart to create an emergency fund to help you keep on track during adverse financial events. The changes you made to get out of debt faster will also help you build up your emergency fund.

Putting it all together

After you have taken these steps, you’ll be well on your way to a debt free life.  And that is a life that carries a lot less stress and money worries.  Just make sure to keep an eye on anything that will get you back in debt. This means you’ll want to continue to track your budget and maintain a close eye on your credit and loan balances.

You don’t need a financial disaster to change your life. If you have debts, it’s time to confront reality. Start making a plan to be debt free, and don’t forget to celebrate your small victories along your way.

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GP

Hi, I'm GP. A personal finance expert with a mission to help Entirely Money readers break free of money worries. Combining a finance-focused education background (B.S. in Finance and MBA with Finance focus) with over 15 years of personal and corporate finance experience to help you achieve your financial best life!

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