Notes on Parenting

Insights for parenting babies, toddlers, teens, and young adults.

Monday, October 18, 2010

How to Become Debt-Free


So you are in debt. And want out.

If you have decided that you want to make a big leap and get out of debt - good for you! That decision will be one of the most liberating decisions you will ever make!

Now, I will say that the process of getting out of deep debt is can often be miserable, but I promise you won't regret it. Ever.


Step One: Stop the bad habits.

Sound easy? You'd be surprised how challenging it can be.

It is absolutely imperative that you stop digging a deeper hole of more debt. Probably the biggest problem with most families is credit cards. If your debt on your credit card (I mean the balance, not the minimum payment) keeps growing and is never being paid off, CUT UP YOUR CARDS! Then, go to a strictly cash budget. Even if you don't have enough money right now to pay off any of the debt on your card, at least you are not going deeper and deeper.

A system that works well for a cash budget is sometimes called the Envelope Method. It will help you get on the right path to spending less than you make, which is key to getting and staying out of debt.

  1. Create an envelope for each category of spending (house payment, groceries, etc.).
  2. When you get paid, get all cash for your check.
  3. Divide the cash between the envelopes.
  4. Use only the cash that is in each envelope for your expenses. When an envelope is empty, you're done spending any money in that category for the month. Any extra goes directly to paying off debt - No shifting cash between envelopes!
This should help you spend less than you make because it will be impossible to spend money that doesn't exist!

Step Two: Start paying down the most expensive debt first.

So now that you have quit diving further into debt by using a strict cash-only budget, it's time to start paying off the debt. And since it's highly unlikely that you'll be able to pay it all off in the first month, step 2 is to prioritize.

How to Prioritize Debt:
Start by making a list of all your creditors, your balance, and the interest rate they are charging you.

Example:

Bank of America Visa: $3750; 22.1%
Ford Credit: $8,400; 8%
Gap Credit Card: $475; 18.9%
Dr. Smith: $800; 10%

Then, rank each creditor by interest rate. Set aside a specific amount each month that will go toward debt reduction. With this amount, starting paying off your debts in order of interest rate (in this example, pay off Bank of America first, then Gap, then Dr. Smith, then Ford). The purpose behind this prioritizing is to get rid of the debt that is most expensive to you first. So, in the case of your Bank of America debt, each dollar in your balance is costing you 22.1 cents per year, whereas Ford is only charging you 8 cents a year on a dollar. (Note: Keep paying your monthly minimum to ALL your debtors as you go through this process to avoid default) Once you pay off one debt, move to the next. And soon you’ll be living debt-free!

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I'm Jenny Willardson from A Young Mom's Guide to Motherhood, Money, & Marriage, and I'm excited to be a new guest author on Notes on Parenting! Look for me every 1st and 3rd Mondays of each month for more advice on family finances.




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