A Simple 5-Step Strategy to Becoming Debt-Free
By: Jon Peters
Tags: Finance, Personal Finance, Money, Self Improvement, Education

But have no fear. While it’s certainly much easier to get into debt than it is to get out, it is possible. Here is my five-step strategy for getting yourself out of debt.

1. Stop creating more debt

“I’m already £1,500 in debt, what’s another £500?” — Me, 2010.

I know what it’s like to be in credit card debt, and I know how easy it is to dig that hole deeper. Reduce your temptation to spend by cutting up your credit cards, or asking your creditors to decrease your spending limit. This won’t help to decrease your debt, but it will stop it from getting any worse.

If it’s credit card debt that you’re struggling with, apply for a balance transfer to a 0% interest credit card. These usually come with an interest-free period of 12 or 24 months, giving you time to concentrate on reducing your debt.

Interest payments are a killer when you’re trying to bring down debt, so getting rid of them (even temporarily) will stop your debt from increasing, which is a huge first step in your journey to becoming debt-free.

Stop creating more debt.

2. Pay more than the minimum repayment

“The monthly repayment is only £20? Brilliant, more money to spend on things I don’t need.” — Also me, 2010.

Do you know why credit card companies keep minimum repayments so low? It’s because they want you to stay in debt. The longer you take to pay off your balance, the more interest they can charge you, and the fatter their pockets become.

By only ever making the minimum repayment, your balance only decreases by a small amount every month, but you’re still paying interest on that balance, which can add up to huge sums over time. Remember, as your balance decreases, your minimum payment will also decrease, meaning it takes you even longer to pay off your debt. For example:

An opening card balance of £2,500 at an interest rate of 20% would require an initial minimum payment of around £65 per month. If you only ever make the minimum repayment amount, it would take 26 years to pay off this debt, and you would pay £3,800 in interest, almost 1.5 times the initial balance. In comparison, making a fixed payment of £65 per month would see the debt wiped out in only five years, with £1400 paid in interest.

Don’t settle for making the minimum repayment. Pay off as much as you can each month.

3. Use existing savings to pay off your high-interest debts

This one may sound counterintuitive, but hear me out.

The average savings rate worldwide is less than 1%. You’re much more likely (as I recently did) to find your savings account interest closer to 0.01%.

Why then, would you keep money in an account earning practically zero interest, while your debt is constantly accruing interest at a rate one hundred, even two hundred times higher?

I understand the importance of having an emergency fund to cover unexpected expenses, but if you are already struggling to repay debts, there is no point whatsoever in having money in savings. You’ll be much better off to use this money to pay off some of your existing debt. This will save you money in the long run by reducing the amount of interest you pay and will help you to clear your debt faster.

4. Focus on one debt at a time

Lots of people have multiple debts. Personal loans, store credit and credit cards are all certain to cripple your finances if left unchecked, and it’s hard to know where to begin when it comes to getting out of debt. It can often seem like a good idea to increase your payments across all of your debts as a way to get out of faster. Paying $100 per month across all my debts is better than $50, right?

Your best bet is to identify the debt that’s hurting you the most, i.e., the debt with the highest rate of interest. Concentrate your efforts into paying off this debt first, while continuing to make repayments on the rest of your debts. Once this debt is eliminated, move onto the second-highest interest debt, and focus on paying this off as aggressively as you can, while maintaining payments on your other debts.

Repeat this process until debt-free.

5. Make some sacrifices

It astounds me the number of people who pay $70 per month for a phone or $80 per month on cable TV, but only make the minimum repayment on their debts.

I’m not telling you that you shouldn’t spend any money on things that bring you pleasure in life. But you should devise a budget that allows you to make substantial repayments towards debts, while still allowing for the occasional splurge. Completely depriving yourself of weekly meals with friends or the occasional non-fat, sugar-free vanilla latte is a sure-fire way to make you throw your budget out the window.

I’m not trying to suck all the joy out of your life. But if you are struggling to get out of debt, maybe spending $150 per month on Starbucks isn’t doing you any favours. If you are serious about getting out of debt, you have to make some sacrifices.