Six Steps to Financial Freedom: A Foolproof System for Getting Out of Debt
by Jason Dean
Millions of Americans roll out of bed each morning knowing that they will only be able to keep a small fraction of the money they earn that day. When payday comes around, not only do they have to worry about Uncle Sam and the state taxing authorities, but a large portion of what’s left will have to go towards paying creditors, and worse yet, the bulk of those payments may not even be applied to the principle on their debts.
If this describes your life, you know that there isn’t an “easy” solution. There is no silver bullet — not credit counseling, not debt consolidation, not debt settlement, and surely not bankruptcy — but while the solution to your debt problem may not be easy, it doesn’t mean it has to be complicated. Yes, getting out of debt will take hard work and discipline, but there is a simple formula you can follow.
Step One: Take out a notebook and write the names of all your creditors in a vertical column. To the right of their names, write your current minimum monthly payments, and in a third column, write the interest rates you’re being charged. Make sure you find out the current interest rate for each creditor, since your rates may have changed — especially if you’ve missed one or more payments to any creditor. This is called universal default.
Step Two: Total up Column B, your monthly payments. Have you been paying at least this much? Can you afford to keep doing so? If so, skip to Step Three. If not, consider credit counseling, a debt management service, or even speaking with a personal bankruptcy lawyer. Good bankruptcy attorneys will often help you find alternatives to bankruptcy if filing isn’t in your best interests — and it rarely is.
Step Three: How much more can you afford to pay? You need to make sacrifices if you want to get out of debt — can you commit to an extra $50? How about $100? An extra $150 or $200 each month would go a long way towards getting out of debt. Where can you cut back? If you eat out twice a week, cutting down to once a month might save you close to $300 — and once you’re debt free, you’ll be able to eat out as often as you want without the side order of guilt.
Step Four: Identify your debt with the highest interest rate and resolve to pay your current minimum payment plus whatever extra you can commit — $50, $100, $150 — whatever you can afford. Also, resolve to continue paying the amounts you’ve written down on your other debts. As you pay down your balances, your minimums will be reduced — but don’t fall for the temptation! Keep on paying the amounts you wrote down and not a penny less (or more — any extra should be applied exclusively to your highest-interest debt).
Step Five: Do not take on any new debt until you reach your goals. This doesn’t mean you can’t use your credit cards — you can use them, but only if you can pay off the new balances in full. If you are worried about your self-discipline, then don’t use your credit cards at all. Put them in an envelop and lock them away somewhere — but don’t cut them up! You need to keep the accounts open to rebuild your credit.
Step Six: Once your first debt is paid off, apply the full amount you had been paying on that debt to your debt with the next-highest interest rate. For example, if your first debt was a credit card with a $75 minimum payment and you were paying an extra $125 each month for a total of $200, then once it’s paid off, apply an additional $200 to your next-highest debt. If that minimum payment was $110, then pay $310, and in no time that debt will be paid off too. Then you can apply an additional $310 to your third-highest debt, and so on. In no time, you’ll be debt free!
Bonus Tip: Don’t be afraid to call up credit-card companies and ask for lower interest rates. You would be surprised at how willing they are to drop rates by a few percentage points. Why? Because the industry is competitive and companies are afraid of losing you to a competitor via a balance transfer. You don’t have anything to lose by asking — don’t be afraid or ashamed. Remember, you’ll be talking to an underpaid call-center employee who won’t remember you ten minutes after she hangs up the phone with you. Give it a shot!