How can five steps on how to get out of debt be called exciting? Well, if I have learned anything about myself and a lot of other people, it’s that achieving a negative goal, such as paying off debt or getting out of something, is never as exciting as a positive one, such as a new car, savings goal, or exotic trip. Therefore, I see no reason why we shouldn’t attach rewards to the completion of personal goals. In fact I have found that I often perform best personally when I manage myself as I would any employee, with carrots and sticks. I used to set a sales goal and if I met it, would allow myself some level of reward. It made work more fun, and it made me more productive.
Step One: Decide on a Reward
So our first exciting step for getting out of debt will be to decide on a reward. Disclaimer: your reward may change – in fact it likely will. I might decide I want a motorcycle when all of this is said and done, but change my mind to a family trip in the process, and be just or more excited about it. I completely understand how stupid this may sound to you now, as your goal may simply be to not lose your house or car, but humor me, and decide on something just for the sake of giving it a shot.
Step Two: Put Out Fires
We must deal with the most threatening situations first, of course, but understand that threats are not the same as consequences. You’ll need to clear your mind – which may have a litany of threats floating around in it – and clearly understand which debts are ready to impose the most serious consequences, and deal with those first.
Make a list of your debts and assess what kinds of debts they are to determine which solutions may be best for your case. A combination of student loans and back taxes, for example, won’t generally be helped with a chapter seven bankruptcy, and if it’s a house you’re trying to save, a chapter thirteen bankruptcy may be the answer. Bankruptcy, however, should be a last resort.
As a last resort, however, bankruptcy has benefits and drawbacks. Just filing creates and automatic stay, which immediately stops all collection activity including foreclosures, evictions, and utility shut-offs. It can even wipe out past due bills for utilities. Bankruptcy is intended to provide an indebted individual or business with a bona fide fresh start.
That said, any bankruptcy filing can result in a negative credit entry that lasts for ten years, and if you want to buy a house, you will likely have to wait two years with good credit in the meantime, before you can get a mortgage.
A chapter seven bankruptcy is called a liquidation, meaning all your assets, except those considered exempt which varies by state, are subject to sale by a trustee in order to pay your creditors. If the value of your non-exempt assets amounts is little or nothing and your unsecured debts are high, chapter seven might be the right answer.
A chapter thirteen bankruptcy is called a wage-earner repayment plan, and with it only twenty percent of your unsecured debts will generally have to be repaid over a period of five years. This plan is usually the one that will help save a home from foreclosure.
If income taxes are your fire, there are several workable solutions as a bankruptcy will stop – temporarily – IRS collection actions but not generally reduce or eliminate tax debt. By filling out a complete financial statement and filing for an IRS Offer-in-Compromise, a Partial Payment Installment Agreement, or arranging an Installment Agreement, you stop all collection actions, and with the first two plans can end up paying just pennies on the dollar of what you owe. These are subject to IRS approval, however, and can be often difficult to get approved.
If it’s unsecured personal or professional debts that are on fire, working out a settlement amount lower than what’s owed or at least making arrangements for repayment could put out the flames.
All of these emergency solutions have in common confronting the problem head on. The relief from just obtaining a written agreement for repayment can mean a lot to your health and sanity!
Assuming you had no fire to deal with, or that your fires are now extinguished, you can begin an erosion or chipping away of your debt.
Step Three: Get Back to Basics
No fires? That’s great! It’s now time to take inventory. Let’s get back to basics. It’s probably a safe assumption that the basics were not in or they were wrong, and that’s at least part of the problem, so quickly assemble the following:
- A Current Bills List
- A List of All Your Debts
- Actual Income
- Actual Expenses
This task alone is often shocking and suggests immediate actions that should be taken. With this information you can now work out a budget. In fact I did this all recently, and it revealed that the margin we had, the amount of income greater than expenses was too small to afford any savings, trips, toys, or debt reduction. Ouch!
In that case we needed to then audit our expenses. Go over every item and decide (a) is it necessary or important, and (b) can it be reduced, even if only temporarily? If you have student loans, for example, you may want to apply for forbearances or deferments until some of your other debt is paid.
Try to arrange a nice margin of income over expenses so there is something with which to pay down your debt every month, and still have enough to live safely.
Here’s the trick: get that money you’re now allocating toward debt reduction flowing constantly, even if it’s only small amounts out of 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 disburse the debt-reducing funds for you.
And make a debt-reduction plan as well. Many advise paying your smallest debts first. This lends to your having successes early on and encouraging continuation of your efforts. I would add you need to assess which debts are most important to pay as well.
Step Four: Widen Your Margin
Go have a nice cold iced-tea because if you’ve come this far you are 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 charged with the exciting task of shrinking expenses and increasing income in order to widen your margin.
Earlier you reduced expenses that were likely just way out of line or dangerous. At this point you can get creative. Fire the cable guy and get Netflix; sell your gas-guzzling conversion van and buy a nice four-cylinder gas-saver or scooter, or even better, get into road-biking to work for health and savings. Plus you look cool.
Simultaneously grow your income. I was amazed, years and years ago, with a credit counselor, that not once did he suggest thinking about making more money! My biggest and best advice here – and this can be dangerous waters, otherwise – is move carefully. Only bet on proven ideas. Only risk money you can afford to lose. There’s no risk at all however, in a second job or profitable hobby that has little or no start-up expenses.
Keep Your Eye on the Mountain
Always be mindful of the horror you underwent that drove you to roll your sleeves up, and the hard work you’ve done to put systems in place to handle your debt. Don’t lapse or let it fall apart. Some would say stay disciplined or stay the course but I find it easiest to think in terms of keeping your eye on the mountain. Keep your eye on your goal, in other words, and if being debt-free is not enough to get you excited, pull out the reward we talked about earlier. Place a picture of the reward somewhere where you will see it often, seriously. It’s easiest to walk a straight line when you keep your eye on your destination and just go there. Try it!
Getting out of debt is a worthy goal. It’s the right thing to do. I congratulate you for wanting to do it! If everyone was as concerned about paying off debt we’d be better people, have happier towns and cities, and a healthier, more stable country. Good luck! Announce it when you’re done, too. 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.