For Millennials, too much debt is their #1 source of financial stress. Particularly they are most stressed about credit card debt (27%) and student loan debt (25%) which studies show are growing with each generation. However, millennials are not the only generational group facing this debt epidemic. All generations have come across a point in their lives where debt has been a huge issue and most of us don’t have the answers on how to get out. This post will give you a step by step guide on what I think are the best steps for becoming debt free!
Step 1: Understand your total debt picture
Like most aspects of personal finance, your debt situation is personal and may vary from others widely. For this reason, understanding your personal debt situation is the first step that you need to take on this debt free journey. So what do I mean by “Understand your total debt picture”? You need to understand how much debt you owe, what types of debt you owe (installment vs. revolving debt), the interest rates of these debt, term length, etc. You can accomplish this by pulling the individual statements from each debt servicer that you have or by calling them and requesting this information. This may take some time but it will be well worth it. Learning this will equip you with the tools you need to execute the remaining steps of this plan.
Step 2: STOP going into to more debt!
When most people hear this step they say “Well duh!”. However, this is not as intuitive as you may think. Most people with high debt don’t have a budget set in place or an emergency fund. Without these two aspects in place its almost impossible not to go into more debt. Without a proper budget you won’t know how much you make (income) vs. how much you spend (expenses) on a month to month basis. For all you know you may be spending more than you make i.e. going into more debt. In addition, without an emergency fund in place what will you do when the car breaks down or the furnace goes out? You will end up putting the expense on a credit card since you have no other money set aside! So to stop going into more debt you must budget properly and have some sum of money set aside for emergencies.
Step 3: Try to refinance any debt you can to a lower interest rate
The average American spends 30% of their lifetime income on interest alone. Interest is like the silent killer, we know its there, but we can’t quite see it coming. For example, how long would it take you to pay off a credit card with a $1,000 balance and a 20% interest rate if you made minimum payments. Drum roll please………. It would take you 4 years and 11 months (59 payments)! And how much would you end up paying back in total? $1,569 in total! That’s almost 60% more than the original balance. So, needless to say that interest can be a problem. Therefore, we want to refinance as much as we can to a lower rate or potentially 0% interest. How do we do this?
Caution: Both options will open back up the available credit or the original credit cards. THIS CAN BE VERY DANGEROUS! I suggest cutting the old credit cards so you don’t be tempted to run back up the debt.
Step 4: Develop a Plan
“A goal without a plan is just a wish” - Antonie de Saint-Exupery. Now that we: understand our debt, ensured that we won’t go into more debt, and refinance to the lowest interest rate possible, we are now ready to develop a plan. The plan will guide us on what debt to tackle first and how much to allocate to each account. The two main debt repayment methods are “Debt snowballing” and “Debt avalanche”. The debt snowball tackles the lowest debt first while still making minimum payments on the other debts. Once the lowest debt is paid off all excess funds go to the next lowest debt. The Debt avalanche follows the same principle but tackles the highest interest debts first. However, you can do a mix of the two or whatever works for you, just pick a method and stick to it.
Step 5: Execute
The last step is to execute! This step is simple and to the point, but it is just as important as the others. You must execute on the plan and make it a #1 priority in your life. If you want to enjoy the feeling of being debt free you must treat it with high urgency and importance.
I hope these 5 steps bring guidance into your debt situation and give you an opportunity to live a debt free life. Take it from me, the feeling is amazing!!!
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