Being in debt isn’t a rare occurrence in America. Studies show that the average U.S. household has an average credit card debt of $5,000.
A debt, when left unmanaged, can create serious financial issues that are hard to get out of. It’s like a quicksand wherein the more haphazard actions you take to get out of the mess, the more you get sucked in.
It’s not too late to resolve your debt problems. Here are the steps you must follow to get out of debt and slowly build your wealth back:
1. Assess the damage
Usually, the root cause of all your debts is your bad spending habits. Acknowledging this fact is the first step toward fixing your debt problems and preventing yourself from falling into the debt trap again.
After understanding that you’re not the victim but the culprit that put you in trouble, you can start objectively assessing the damage your debts made.
List down all your debts, including credit card balances, mortgages, car loans, and even student loans. Trace back expenses, including the money you spent on grocery purchases, clothes, luxuries, and leisure and entertainment. You should also write down all sources of income within the household to get a better perspective of your finances.
Look at your debt-to-income ratio and check if it’s greater than 30% – any number above this is already a warning of imbalance on finances. You can derive this percentage by comparing all your monthly debt repayments with the total household income per month.
By laying down everything on the table, you’ll be able to spot areas of concern and the resources available which you can use to plug the leaks in your financial reservoir.
2. Set up a debt repayment plan
People commonly use two types of strategies in repaying their debts: debt avalanche or debt snowball.
With debt avalanche, you focus all extra money into repaying the debt with the highest interest first. This has the advantage of largely bringing down the interest cost on the debt.
However, focusing on the debt with the highest interest may not be emotionally satisfying if it’s also your largest debt. You’ll feel that you’re not making a dent since it will take longer to clear out the balance.
On the other hand, the debt snowball strategy lets you build momentum by repaying smaller debts first. This method is more satisfying since you’ll be eliminating more items off your list. However, the downside is you’ll be allowing the larger debts to grow bigger.
Developing a balanced approach in tackling your debts is possible by creating different repayment scenarios. Compute how much your debt will grow if you proceed with paying the smaller or the bigger one first. The scenario that will give you the least debt increase is usually the best method to go with.
Consider also halting investment contributions. Your focus should be on clearing out all your debts first, so every ounce of resource count. When you’ve repaid all your debts, it’ll be easier to reinvest your money in different financial instruments.
Once you have a plan, stick with it until the end. Stay focused in repaying all your debts first and avoid adding expenses to the pile. Finding an additional source of income, selling unwanted items, and squeezing every extra cash you have into debt repayment are some of the actions to take to speed up clearing the balance.
3. Cut off expenses
Avoid using your credit cards because they have high-interest rates that will just dig you a deeper financial hole. Ask the bank if you can qualify for a lower interest rate so it’ll be easier to repay the balance.
Buy unbranded goods, shop at a discount grocery store, cut cable subscriptions, switch to a cheaper cellular plan, eat at home more often, stay at home during Black Friday – there’s practically an infinite number of ways to cut off expenses. You just have to be dedicated and stick only with the necessities if you plan to clear off your debts as soon as possible.
Track your daily, weekly, or monthly spending to ensure you’re not going over the budget. Train yourself to control emotional shopping and develop accountability in handling money to avoid backsliding into old spending patterns.
When you start cutting off unnecessary expenses, you’ll find that you have more money than expected. You’ll also stop living from paycheck to paycheck since you’ll be into the habit of spending less than you used to. With all the extra cash you have, you’ll repay all your debts in no time.
4. Start investing
After you’ve cleared all your debts, it’s time to rebuild your wealth and grow it to a size bigger than before. You can also begin building up your credit score after clearing your credit history.
If you stick with the plan to reduce your expenses, avoid unnecessary credit card use, and stop from taking more loans, you’ll find that you have more cash than you’ve ever imagined. Once you’ve become used to living within your means, you’ll be used to the habit of saving every bit of money you get your hands on. This is the time to grow your money and never look back on getting into debt again. From here you can start to look at increasing your income, even if you’re busy at work, there are tons of opportunities to make money from home. And then, of course, you want to invest your hard-earned money.
For starters, it’s best to begin with simple investment options that are low-risk but provide higher returns compared to the typical savings account. Certificates of deposit (CDs) and treasury bonds are good options to consider since they guarantee the return of principal.
If you’re ready for a bit more risk, investing in dividend-yielding stocks, mutual funds, and P2P lending might be to your liking. These financial instruments offer a chance for higher returns, but at the risk of losing a portion of your capital.
Whichever investment vehicle you choose, remember not to put all your eggs in one basket. Always prioritize risk management to avoid getting into debt again.
There’s no quick way to get out of debt and rebuild wealth in an instant. It will take months to even years of patience and hard work to recover from over-indebtedness and clear your credit history.
The best method to avoid going into debt is to spend less than you earn. With something as simple as this, you’ll already be making yourself a huge favor that you’ll be thankful for in the future.