How to Get out of Debt (And Stay Out of Debt)

How to Get out of Debt (And Stay Out of Debt)

According a 2018 survey put out by Northwestern Mutual, The Average American is in $38,000 of debt (and that’s not including mortgages). One quarter of this debt is in the form of credit cards debt. To make matters worse, 2 in 10 Americans spend over 50% of their income just on debt repayment. That means that 20 percent of the country is spending the bulk of their paycheck every month just treading water, leaving little left over for basic necessities.

And with the advent of companies like Affirm and After Pay its likely only to get worse, as businesses make it ever easier for consumers with poor credit to make more instant purchases on items they can’t afford. Never mind that these ‘buy now, pay later’ companies are actually profiting from your inability to pay.

Understanding Why You’re in Debt

If you’re serious about paying off your debt, the first thing to realize is that unless the bulk of your debt is from medical bills, student loans, or unforeseen emergencies, your debt is likely totally preventable. You’re not in debt because you don’t make enough money. Even if you doubled your salary you’d might still find your way into debt.  It’s a phenomenon known as Lifestyle Inflation. Basically, when people get raises, they increase their spending to match their income. Almost everybody does this. Look back to your college days for instance. If you were like me, you were dirt poor, living off rice and beans, splitting your housing bill with 4 or 5 other roommates.  You probably didn’t even have your own room.  You might not have even had a car. Most months I could keep my expenses to under $700 a month.  Not anymore. While I tried to keep living cheap for a while, once I got my first real job I got my own place, bought a new truck, and started eating out more often. Lifestyle Inflation.  We have a tendency to think that once we make more money, we deserve that money.  And so we spend it.

What many people don’t realize, is that debt is not primarily driven by income. There’s plenty of people making 6 figure salaries that are still in debt. You see, debt is as much or more a function of how much you spend your money than it is a function of how much money you make. If you can’t manage your money now, you’re unlikely to be able to manage your money in the future, even if you do end up making more money.

But even if your debt is a result of medical bills, student loans, or an unforeseen emergency, this article will still help you pay it off.

Where to begin

Now that you understand the reason for your debt, you can begin to understand how to pay it off. You might actually be grateful to realize that the key to controlling your debt is controlling your expenses. You see, its much easier to reduce your expenses. Its something that is completely in your control. Increasing your income is doable as well (by getting a second job, working overtime, asking for a raise, or getting a better job among other options) but not all of these options are always in your control, and some could take months or years to achieve. Reducing your spending on the other hand, you could start doing that today.

The first step is to understand where exactly your money is going. Start to track all the money you spend in the next month and categorize it into three different groups 1) Living Expenses, 2) Debt Repayment, and 3) Discretionary spending. Discretionary spending being spending that isn’t absolutely necessary.  Things like going out to eat, going to the movies, and ordering takeout for instance. Once you’ve spent a month tracking your spending, you can see where your money is going.

Now that you understand where your money is going you can begin to cut down on your expenses. It should go without saying that if you’re serious about this, you need to be serious about sticking to your budget. No ‘Cheat Days’, no ‘Treating Yourself’. Its that kind of an attitude that got you into this mess in the first place. You need to be disciplined now.

The second step is to go through your discretionary spending and find obvious places to ‘trim the fat’ out of it. Are you ordering your food from door dash? Getting your pizzas delivered? Better yet, are you going out to eat at all? If you’re serious about cutting out your debt aim to go out to eat no more than once a month. Pack lunches to school or work, cook dinners at home, that sort of thing. And how about shopping? When’s the last time bought an item of clothing? Try cutting out any shopping sprees while you work to pay off your debt. You probably you really need new clothes as much as you think. If you did, You could always go to good will and pick some up second hand for much cheaper.

The third step is to look back at your living expenses. I know we said those were mandatory expenses but the truth is, while you cant eliminate your living expenses, you can often lower them. From reducing your electricity bill to swearing off buying name-brand items, to moving into a smaller apartment or renting out a room in your flat, there are ways to further reduce these expenses.  My wife and I recently downsized from two vehicles to one for instance.  This has lowered our debt repayment obligations substantially.

Paying it off

Now that you have these three steps done we can take a look at your debt repayment. Take a moment to categories your debts. Separate them all out by the interest rate and debt amount. Accounts with the highest interest rates, and lowest balances should be paid off first. Take all the additional money you managed to squeeze out of your budget and Target the account with the highest interest rate, paying only the minimum amounts on the other accounts. If multiple accounts have similar rates, start with the account with the lowest balance. Once this is paid off, use all of the money you were putting to this account and put it to the account with the next highest interest rate. As you begin paying off each account, you will notice that you have additional money to put towards the others. This is called the Debt Snowball method of debt repayment. You may start with only a little bit of cash to put towards debt repayment, but as you make progress you will have more and more as the number of accounts you are paying on each month decreases.

Staying out of Debt

Finally, when you come out of debt for good, you should remember that you didn’t come all this way only to fall back into debt later.  Don’t relax your focus in keeping down your expenses.  Now is your chance to finally put your money to work for you instead of working for your money.

The first step in this stage is to begin putting the money you were applying towards debt repayment and put it into building your savings instead.  You’re going to want to build a 3-6 month emergency fund.  Basically, how much money would you need to survive (not thrive, just survive) for the next 3-6 months?  What ever it is, start saving up that amount.

The second and final step, once you have your emergency fund established, is to start investing your money.  Put it in Retirement accounts, put it in brokerage accounts, invest it on Real Estate Platforms, put it anywhere you can net a return.  The key with investing your money is to make sure it is in a diversified account with low management fees.  Investing your money will allow you to start earning interest instead of paying interest.

Once you begin to follow these steps, you will find yourself on the path to financial independence.

Thanks for tuning in. For other articles on making your path to financial freedom, check out my website Ask the Savings Guy.  If you’re serious about saving for retirement, please check out Why You’ll Never Retire, Unless You F.I.R.E.

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