How to Get Out of Debt

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$137,879. This is the average amount of debt per household in the United States as of the end of 2019. Of those with credit card debt:  average balance of $7,104. Average auto loan balance? $27,934. Student loans? $46,679. These are staggering numbers. And if you are reading this post, chances are that you find yourself with at least some kind of debt. Learn how to get out of debt with a few simple steps to regain financial control over your life.

Stop Adding New Debt

The very first step in taking back control over debt is to stop adding new debt. If you have credit cards and carry a balance month to month, adding to the pile stops today. Stop using your credit cards.

But without spending on a credit card, how will I afford to live, you ask? You’re going to learn to budget, which I’ll cover shortly. It doesn’t matter what your income is, if you continue to add to your balances, you will never get out of the hole.

Credit cards are the biggest offender, but it goes without saying that if you have existing consumer debt, you shouldn’t be buying a new car, taking out personal loans, or opening up any new credit lines.

Get Out of Debt

Take Stock of Existing Debt & Prioritize Your Payments

The next step in the process is to understand just how much debt you have.

We get it, it’s probably a scary pile. But in this case, ignorance is not bliss.

Get out all your credit card statements, car loan statements, student loan statements, and any other debt-related financial statement. Note that I did not mention mortgage payments, which I will explain below.

Once you have all your statements in front of you, we’re going to prioritize which ones to pay first.

To prioritize your payments, we’re going to use math. We’re going to knock out the most expensive debt first. So, take all of your debt and rank it from the highest to the lowest interest rate. When you’re done, it’ll look something like this:

  1. Credit Card A – $5,000 balance, 24% interest rate
  2. Credit Card B – $2,200 balance, 18% interest rate
  3. Student Loan A – $19,000 balance, 8% interest rate
  4. Student Loan B – $1,500 balance, 6% interest rate
  5. Car Loan – $13,500 balance, 5% interest rate

Some financial “experts” will tell you that you should prioritize “quick wins”, like paying off a small balance first.

I am here to tell you, this advice stinks. It will cost you more in the long run because you’ll pay more in interest. Our recommendation here is to minimize how much interest you pay. Period. We believe in math, not feelings.

If you have a lot of expensive credit card debt, consider consolidating your debt through a platform like Lending Club, which offers personal loans up to $40,000 with interest rates as low as ~10% for those with the highest credit scores. Just remember, it only makes sense to consolidate your debt if you can do so at a lower interest rate.

Once you have all of your debt organized, we’re going to help you develop a plan to pay it.

Bills

Budget for Your Debt

You ended up with debt because you did not budget. Budgeting is the only way to get out of debt, and the only way to ensure you do not end up back in debt in the future.

I realize I sound like a bit of a broken record on this blog, but that’s because budgeting is the single most liberating thing you can do for your finances. It helps you realize what you can afford, and help you move towards what financial goals are important to you.

Trust me, once you have a budget that works, it feels good.

Where to Budget your Money

If you’re trying to decide how much to budget towards your debt, start with this. I am permitting you to stop funding any other financial goal (retirement, emergency fund, etc.) until you pay down your most expensive debt.

If your debt carries an interest rate of >10%, you will not earn this by investing (over a long period). The debt will always be more expensive than what you can earn by investing.

If, however, your debt is in the 6-7% range, it’s really up to you if you’d rather pay down debt or invest. We’d likely choose to pay down the debt because of the psychological satisfaction.

If your debt is cheap, say 3-4% (e.g. a mortgage), invest before paying down debt.

Check out our guide on Where to Save & Invest First for more detail on why we recommend this.  

How Much to Pay Towards Debt

You’ll need to decide how much to funnel towards your debt each month. We would urge you to put 20% of your income towards your debt. If you’re in debt, we get it, this probably sounds like a gargantuan number. If you have to, start with a lower number like 10%, but work your way towards 20%.

You may be asking yourself how you could afford to put 20% towards your debt. You probably got into debt because even spending 100% of your income wasn’t enough to get by.

Here’s the hard truth:  if you can’t afford to put 20% of your income towards savings goals, your lifestyle needs an adjustment. Find a cheaper apartment, get a cheaper car, eat out less, etc.

Here’s the good news:  starting a budget will make it easier than ever to understand what you can afford and where your money is going. You’ll be able to cut back without feeling like you’re cutting back.

If you are just getting started with budgeting, we would urge you to check out the app we use – You Need a Budget. We started saving $1,500/month using YNAB, and that’s why we’re so sure it can help you reach your financial goals (check out our story here).

Lastly, if you’re serious about learning how to get out of debt, remember this. Paying the minimum payment will never work. That number you see on your statement is just a tease to keep you in debt. You must go above and beyond.

Pinching Wallet

When is Debt Okay?

There are very few types of debt we bless here at ASF.

  1.  Mortgages (usually)
  2.  Student loans (sometimes)
  3.  Car loans (in limited amounts)

Mortgages

When it comes to mortgages, usually we view them as a valuable tool to acquire property that you could otherwise not acquire outright. That said, don’t bite off more house than you can chew. If your house is too expensive, it will put stress on every other aspect of your life, so make sure you can afford the house before you buy it.

NerdWallet offers a great home affordability calculator to help you figure out what you can afford. Here’s an even simpler guide:  if making the payments on a 30-year mortgage would be a stretch, it’s too much house. Aim to spend no more than 28% of your gross monthly income on your housing.

Student Loans

Student loans are a divisive topic. In certain instances, we think they can make a lot of sense. If you went for an undergrad degree in English, chances are good you’re not making much upon graduation. If you decide you want to get an MBA at a top 10 school, take on $150,000 of loans, but take your salary from say $50,000 to $120,000/year, do it. But only if you’re willing to take a job in the field in which you study and accept the lifestyle that comes with that (i.e. long hours, corporate America).

Second, only take out student loans if you’re getting a degree that has the earning potential to pay back those loans. Unfortunately, taking out student loans for liberal arts degrees is often a bad idea.

We heard a fantastic quote a few days ago. College is not a place to explore a passion. If you spend the money to go, it’s an investment in your career. Only go and take out loans if there’s a payback.

Looking for some guidance? Check out the average salaries of people in your considered field and then determine if that is worth taking out loans that may take many years to repay.

Check out this After School Finance guide to paying off student loans if you want some detailed guidance.

Car Loans

Cars are expensive. We get it. Some people say you shouldn’t, under any circumstances, take out a loan for a car. Here at ASF, we’re a bit more realistic than that.

If you need a new car, buy a reasonably-priced used car that will fulfill your needs. We used to like buying new cars too. Until we realized it was the single worst way to spend money.

Cars are depreciating assets, so let someone else pay the depreciation. The sweet spot is buying a 3-year old car with <30,000 miles. Someone will have often paid half the value of the car in depreciation. And the car you’re getting will look like new, have limited maintenance requirements, and last for many, many years.

Additionally, if you need to take out a loan for a car, save some cash for the down payment. It will reduce your monthly cash flow burden and lower the amount of debt you take out to finance the car.

Continue What You’ve Started

If you’ve successfully taken all the steps so far in this guide on how to get out of debt, you’ve made tremendous progress. As you work your way out of debt, remember to continue what you’ve started.

Once you get out of debt, don’t send yourself back down the black hole. There will come a time when it’s okay to use a credit card again but only if you budget every month and live within your means.

Debt stinks, but once you wrap your arms around it, you’ll feel a lot better about your financial situation. So, start your journey today to eliminating harmful debt!

Do you have a debt payoff success story to share with us? Let us know in the comments below!

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