5 Things You Need to Do to Pay Off Your Debt
If you’re having a hard time managing your credit card or loan debt, you’re far from alone. Millions of people are in the same boat, which is why financial services companies have devised so many different ways to help. Examples include debt counseling, debt consolidation loans, and balance transfer credit cards. All of them have their time and place, but none of them are as good as digging in and paying off your debt on your own.
Here are five key things you need to do to achieve that goal.
Do an Honest Analysis
No matter what your financial situation may look like, you’ll never solve your debt problems if you don’t face the music. It is not uncommon for people to just bury their heads in the sand and deal with snowballing debt problems by pretending things aren’t all that bad. This will only leave you trapped in the cycle of debt, and it carries a very real risk of bringing you to a much worse place than you’re already in.
So, here’s what you should do at this stage:
- Make a list. Open a spreadsheet and tally up all your debts: every credit card, every personal loan, every payday loan, every IOU to friends and family members. Track the interest rates attached to each debt, then add up the total amount of money you owe.
- Figure out your debt-to-income ratio. The best strategy for any given situation depends heavily on the relationship between your debt and your income. This is called your debt-to-income ratio. It expresses the percentage of your total pre-tax monthly income that you must spend to meet your monthly obligations on things like credit cards, car payments, and personal loans. Mortgages are not usually included, but it’s wise to count any student debt you may have.
- Examine your spending habits. If you have receipts or other means of tracking your recent spending, do an audit. Categorize your spending under headings like housing, transportation, clothing, food, entertainment, and discretionary purchases. If you can’t get an accurate handle on your spending retrospectively, start tracking it now and assess it over the course of the next month or two.
Working with firm, accurate numbers is key. This step might not be easy, but it’s definitely essential.
Reconsider Your Budget
Tracking your spending over a month or two will help you identify areas where you could improve your approach. Look for common bad habits, such as:
- Spending too much money on eating out and other inessentials, like daily take-out coffee from a pricey cafe
- Overspending on non-essential items
- Failing to account accurately for variable monthly costs such as utility bills
- Committing to memberships or services you don’t actually use enough to justify the costs of
- Buying expensive items without figuring out how they will impact your overall financial health
These types of habits are budget-killers. To become debt-free, you’ll need to impose greater levels of responsibility and self-discipline, at least temporarily. The higher your debt, the truer this adage will be. Cut unnecessary spending wherever you can and recommit that money to paying off your debts.
Set Goals and Implement a Plan
Finance gurus often talk about the psychological power of setting goals and creating plans to reach them. To become debt-free, you’ll need a specific end objective as well as a way to get there. At this stage, you’ll want to consider questions like:
- What is a realistic time frame for becoming debt-free?
- What is the maximum amount of money you could commit to paying down your debts each month?
- Do you have any options for increasing your income or generating extra money, such as taking on a part-time side job or selling off unused valuables?
Consider multiple scenarios. For example, if you’d like to be debt-free in a year, try recalculating the numbers with a time horizon of nine months or 18 months to see how it would affect your plan.
In coming up with your strategy, remember: the key to success is making changes you can live with. Your plan won’t work if it isn’t realistic.
Avoid Accumulating New Debt
This step is critical: while you work to dig your way out of your current debts, you should do everything in your power not to add to your debt load. Bloating your existing debt will only delay your success, and in a worst-case scenario, it could completely derail your progress.
Depending on your spending habits and personality, here are some tips and strategies you can try:
- If you must use your credit card to make a purchase, pay off the new purchase immediately and in full
- Talk to your credit card company about temporarily (or permanently) reducing your account limits
- If you shop online with retailers like Amazon or eBay, remove your credit cards as saved payment methods and start shopping offline as much as possible
As a last resort, you could also close one or more of your current credit card accounts. This will result in a ding on your FICO credit score, but that’s a minor downside that may well be worth it in the long run.
Stay the Course
Commitment, focus, and discipline are the keys to success in becoming debt-free. If you’ve budgeted correctly, and if you’ve managed to get the numbers to line up in ways you can live with, executing your plan should go smoothly.
One psychological trick you can use to make the whole process easier is to build a small bonus fund into your monthly budget. Every month, you can sock away a small percentage of your income, like 5% or so, and treat that money like it doesn’t exist while simultaneously keeping track of it. Then, you can reward yourself for sticking to your plan by using that money to get yourself a small treat at the end of the month. Alternately, you can let it roll over from month to month and save up for a bigger reward.
If you’re still having a hard time getting out of debt, or if you’ve encountered unexpected expenses or financial obstacles that impact the plan you’ve made, you may need to consider other options. Debt counseling and consolidation loans are usually the best places to start if you need some outside help to reach your financial goals.