8 steps to get out of debt

debtBorrowing money is easy, paying back is harder. Money is not free and when using debt, one should always think who benefits and who does the opposite. It might feel attempting to pay your debt in small pieces, over longer periods of time. The reality is that credit companies are happy milking money as long as possible, taking more money in the form of interest and fees.

It would be best to avoid debt and get out current debt as fast as possible, with the best possible terms. I will list how you can get out of debt.

1. Stop borrowing money

Credit cards and consumer credits are services that are easy to use, you don’t even notice how fast your loans grow into a big stack of debt. To make possible to get out of debt is important to stop borrowing money. You should cut expenses or pay your living in other ways, like using savings.

2. Find the root cause of the problem

Usually, why there is debt in the first place is the lack of money. There are also other stories that can end in debt. There may be divorce and large investments to get new life on its tracks, with the new apartment. The car suddenly breaks and you have to buy another to get to work. One thing that I have done is using debt as a tool. I like the idea that I could pay my purchases month later. After a month came time to make the payments. I didn’t want to pay and put the money in savings instead. Suddenly there was more loan that I thought. Loans have trap built-in. Mentally it’s hard to make payments and harder it gets when sums are larger. Growing debt is also easy, taking loans over another, or to pay the loan with a loan. When you realise what is the cause of your situation, it’s easy to understand how to make a change in habits and live correctly.

3. Make emergency bumper

First, make yourself an emergency fund. Save $1000 to separate bank account. You can use savings instead of new loans. When using your emergency fund remember to pay back to the account. If you first save $1000 and then spend it, the idea does not work.

4. Get lower interest rates to your current loans

Credit cards have usually the highest interest rates. Try to negotiate a lower interest rate if possible. You can also take a bank loan with lower interest and combine your smaller loans together. At the end, you have one big loan, instead multiple loans with higher interest rate. Part of your monthly loan payments are handling fees, more loans, more fees. By combining loans fees are also lower.

5. Make a budget

Budget and plan your usage of money. It’s important to get logic to the usage of money: Calculate how much you earn, what expenses you have, how much you would like to save. In my first blog post wrote about making a budget. Most important part is the debt. Cut other expenses as much as possible and use available money to pay your debts.

6. Make a debt snowball

If  you have multiple loans, list the loans. Put the loan with the lowest balance at the top of the list and the largest in the bottom. Don’t pay all loans with an equal amount. To get the momentum you should focus to the smallest loan first and after that to the second smallest, move down on the list until you have paid all the loans. Pay minimum monthly payments to all other loans except the smallest which you should pay as much as you can. After you get the first loan done, you have more money to tackle with the next one. The cycle keeps repeating until you have paid all your loans, in accelerated time.

7. Don’t stop saving to pay debt

It is important to continue saving while paying the debt. If you think that it would be wiser to handle the debt first and save money after, it’s not true. Let’s think two scenarios:

  • You pay your debt in 5 years and after paying your debt you save $100 per month for 5 years with a yield of 8%. From 5 years total saved money would be $6000 from the period and the value of savings would be $7344 with interest.
  • You pay your debt and save $50 per month at the same time, for 10 years with a yield of 8%. At the end, you would have saved same $6000 but the sum with interest would be $9070.

Calculations show that it’s best to save money while paying the debt. You should spend more money on debt and less on savings, but do not quit saving money.

8. After it’s all done

When you are free of debt, it’s important to learn from the past and avoid taking new debt. If you think that it’s ok to take a new loan when there it’s no loan left, is dumb. What was the idea behind getting out of debt in the first place? Think that you have had a $1000 consumer loan with high 12% annual interest rate. After paying the loan in a year, you take another consumer loan with $1000 and 12% interests rate. Now you are back in the beginning. It just doesn’t make sense.

 

 

 

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