How can five steps to get out of debt be called exciting? Well, if I’ve learned anything about myself and many others, it’s that achieving a negative goal, such as paying off debt or escaping a difficult situation, is never as thrilling as a positive one—like buying a new car, reaching a savings goal, or going on an exotic trip. Therefore, I see no reason why we shouldn’t attach rewards to the completion of personal goals. In fact, I’ve found that I often perform best when I manage myself as I would any employee, using incentives and consequences. I used to set a sales goal, and if I met it, I would allow myself some level of reward. It made work more enjoyable and increased my productivity.
Step One: Decide on a Reward
Our first exciting step for getting out of debt is to decide on a reward. Disclaimer: your reward may change—in fact, it likely will. I might initially decide that I want a motorcycle, but change my mind to a family trip during the process, and end up just as excited about it. I understand how silly this may sound to you right now, as your goal may simply be to not lose your house or car, but humor me and choose something just to give it a shot.
Step Two: Put Out Fires
We must address the most threatening situations first. However, remember that threats are not the same as consequences. Clear your mind, which may be cluttered with worries, and identify which debts pose the most serious consequences. Deal with those first.
Make a list of your debts and assess their nature to determine the best solutions for your situation. A combination of student loans and back taxes, for example, won’t typically be resolved through a Chapter 7 bankruptcy, and if you’re trying to save your house, a Chapter 13 bankruptcy may be the answer. However, bankruptcy should always be a last resort.
While bankruptcy has benefits and drawbacks, filing creates an automatic stay that immediately stops all collection activities, including foreclosures, evictions, and utility shut-offs. It can even eliminate past-due utility bills, providing a genuine fresh start.
That said, any bankruptcy filing can result in a negative credit entry lasting ten years. If you want to buy a house, you’ll likely need to wait two years with good credit in the meantime before you can secure a mortgage.
A Chapter 7 bankruptcy is known as a liquidation, meaning all your assets, except those considered exempt (which vary by state), are subject to sale by a trustee to pay your creditors. If the value of your non-exempt assets is minimal and your unsecured debts are high, Chapter 7 might be the right option.
A Chapter 13 bankruptcy is referred to as a wage-earner repayment plan, where only about twenty percent of your unsecured debts generally need to be repaid over five years. This plan is usually the best way to save a home from foreclosure.
If income taxes are your immediate concern, there are several workable solutions. Bankruptcy will temporarily halt IRS collection actions, but it usually won’t reduce or eliminate tax debt. By submitting a complete financial statement and filing for an IRS Offer-in-Compromise, a Partial Payment Installment Agreement, or arranging an Installment Agreement, you can stop all collection actions. The first two plans may allow you to pay just pennies on the dollar, though they are subject to IRS approval and can be challenging to obtain.
If you’re dealing with unsecured personal or professional debts that are on fire, negotiating a settlement for less than what you owe or at least arranging a repayment plan could extinguish those flames.
All these emergency solutions share a common theme: confronting the problem head-on. The relief from obtaining a written agreement for repayment can greatly benefit your health and sanity!
Assuming you have no fires to deal with or that they are now extinguished, you can begin the process of eroding or chipping away at your debt.
Step Three: Get Back to Basics
No fires? That’s great! It’s time to take inventory. Let’s get back to basics. It’s safe to assume that the basics were either missing or incorrect, contributing to the problem. Quickly assemble the following:
- A Current Bills List
- A List of All Your Debts
- Your Actual Income
- Your Actual Expenses
This task alone can be shocking and suggest immediate actions you should take. With this information, you can work out a budget. I recently did this, and it revealed that the margin we had—the difference between income and expenses—was too small to allow for any savings, trips, or debt reduction. Ouch!
In that case, we needed to audit our expenses. Go over every item and decide (a) is it necessary or important, and (b) can it be reduced, even temporarily? If you have student loans, for example, consider applying for forbearances or deferments until some of your other debts are paid.
Aim to create a comfortable margin of income over expenses, ensuring you have something to pay down your debt each month while still living safely.
Here’s the trick: get the money you’re now allocating toward debt reduction flowing constantly, even if it’s just small amounts from every influx of income, and get rid of it fast! Otherwise, reasons will arise to use it, and you won’t be getting out of debt! If necessary, trust someone else to hold and manage the debt-reducing funds for you.
Also, create a debt-reduction plan. Many advise paying off your smallest debts first. This approach allows you to achieve early successes, encouraging you to continue your efforts. However, also assess which debts are most important to pay off.
Step Four: Widen Your Margin
Go enjoy a nice cold iced tea because if you’ve come this far, you’re already starting to feel great relief from your hard work, and a debt-free life is on the horizon! Now it gets fun!
Like all business legends, you are now tasked with the exciting job of shrinking expenses and increasing income to widen your margin.
Earlier, you reduced expenses that were likely excessive or dangerous. Now, you can get creative. Consider firing the cable guy and getting Netflix; sell your gas-guzzling van and buy a fuel-efficient four-cylinder car or scooter, or even better, start biking to work for both health and savings. Plus, you’ll look cool!
At the same time, grow your income. I was amazed years ago when a credit counselor didn’t once suggest considering making more money! My biggest and best advice here—though it can be risky—is to move carefully. Only bet on proven ideas, and only risk money you can afford to lose. However, there’s no risk in taking a second job or pursuing a profitable hobby with little or no startup costs.
Keep Your Eye on the Mountain
Always remember the hardship that motivated you to roll up your sleeves, as well as the hard work you’ve done to manage your debt. Don’t let it fall apart. Some would say to stay disciplined or stick to the course, but I find it easier to think in terms of keeping your eye on the mountain. Keep your focus on your goal, and if being debt-free isn’t enough to excite you, pull out the reward we discussed earlier. Place a picture of the reward somewhere you’ll see it often. It’s easier to walk a straight line when you’re focused on your destination.
Getting out of debt is a worthy goal; it’s the right thing to do. I congratulate you for wanting to achieve it! If everyone were as concerned about paying off debt, we’d be better people, live in happier communities, and have a healthier, more stable country. Good luck! And when you’re done, announce it! Make it cool. After all, getting out of debt and being financially free to create the life you want for yourself and others is definitely cool—very cool.
