Summary: Based on the concepts of awareness, anticipation and action, my get out-of-debt plan is aimed at individuals who face financial difficulties and seem to be accumulating more debt instead of taking control of their finances.
As a financial adviser, I highly value financial independence. Particularly, after the recent credit crisis that hit the economy forcing many firms out of business and millions of households into poverty, I consider financial freedom as a means to future success.
Personally, I carry a debt of $7,500 in credit cards, a student loan of $2,000 and a car loan of $1,500. I pay monthly installments of $1,300 for this $11,000, and according to my amortization table I will be able to completely pay off my debt after 15 years. To get an idea of how an amortization table should look like, click here.
The three A’s of My Get Out-Of Debt Plan
To improve my financial situation within 2011, I have crafted a get out-of-debt plan that is aimed at individuals who face financial difficulties and seem to be accumulating more debt instead of taking control of their finances. If you are getting deeper into debt, have a look at my suggestions below. Maybe they can help you get your finances back on track again.
My get out-of-debt plan is based on three concepts: awareness, anticipation and action. In the context of personal finance, these concepts are highly valued because they can offer guidance and financial stability in the long run.
Some people complain about how they cannot get out of debt although they don’t know how much their debt is. It is impossible to take control of your financial situation if you are not aware of it.
List all your debt including credit cards, car loans, student loans, personal loans, and medical bills and sum them up including decimals for accuracy. Keep in mind that when adding many numbers decimals can generate a completely new figure, which will then be used in another arithmetic operation and produce an entirely wrong figure. At the end of the day, the picture you will have for your financial situation will be mistaken. Therefore, it is critical that your debt figures are 100% accurate.
Other important steps in this stage include:
Creating a debt allocation table
After you have listed and summed up all your sources of debt create a debt allocation table to see how your debt is allocated in different sources, where you owe more and what the interest rate for each debt is.
Your table can have three columns named “Debt”, “Amount Owed” and “Interest Rate”.
In column “Debt” include each source of debt you have. If you have three credit cards, include each credit card in a separate line because your cumulative credit card debt may be $20,000, but each credit card has different interest rate and different terms of payment.
In column “Amount Owed” include the correspondent amount in each source of debt.
In column “Interest Rate” include the correspondent interest rate to each source of debt.
To get an idea of how your debt allocation table should look like when completed, click here.
With a grand total of $32,100 you need to 1) religiously stick to your monthly payments; 2) try to make more than the minimum credit card payments. I will explain more in the Action section.
Creating a budget
To create a successful budget you need to analyze your financial situation honestly and realistically. Figure out how much you earn on an annual basis and make sure to include all sources of income. It is critical to know exactly how much money you make because this is the money you can afford to spend.
Then, include all sources of expenses in order to know how much money you spend on fixed expenses including rent or mortgage, gas, utilities, and insurance and adjust your variable expenses accordingly by spending less on groceries, entertainment or personal care.
Make sure that your budget is realistic, accurate and flexible. By keeping a realistic budget you can cover your expenses, but most importantly, save money on a regular basis. Besides, an accurate budget gives you the freedom to enjoy your life without being deprived because you know you can really afford these purchases without putting your financial future at stake. Finally, a flexible budget enables you to make well-informed decisions about your finances.
Being able to anticipate sudden expenses allows you to stay within your budget. To achieve that, you have to be able to save as much money as possible. This might require some drastic changes in your lifestyle, but it will certainly help you become financially independent.
Some important steps in this stage include:
Controlling household spending
If you don’t control your household spending, not only you accumulate more debt, but you ultimately hurt the economy that cannot burden such high levels of consumer spending.
You can control your grocery shopping by planning your meals, making a grocery list and stick to it, buy in bulk, keep food in your freezer, stock up non-perishable items, and use coupons. Besides, you can lower your energy bill by controlling your thermostat, using energy efficient appliances and bulbs and installing insulation.
You can also use the envelope system to manage your cash. Identify your spending categories including groceries, gas, utilities, insurance etc., create an envelope for each category and allocate the proper weekly or monthly amount of cash to each. Once your balance is zero and the envelope is empty, you cannot spend anymore. Soon, you will spend only when you have to, cutting back on unnecessary spending.
Set up an emergency fund
By setting up an emergency fund you achieve two things at once: 1) you avoid borrowing from your IRA or liquidating your 401k, meaning you ultimately avoid taxation and 10 percent penalty and 2) you avoid borrowing from your already overcharged credit cards. It is tempting and possibly convenient to charge your credit card for a financial emergency, but the truth of the matter is that the infinite spiral of credit card charging accumulates more debt.
Set three to six months worth of your living expenses aside in an emergency fund to cover up for a sudden job loss or a huge medical bill. Also, make sure to keep your emergency fund in a money market account (MMA), a regular interest-paying checking account or a certificate of deposit (CD). All these options allow you to withdraw money, with or without penalty, and are insured by the Federal Deposit Insurance Corporation (FDIC).
It took me quite sometime to take action on managing my debt mostly because I didn’t exactly know what to do. Although my debt is not as high as in the example used in the debt allocation table, still I need 15 years to pay off my debt, which is a lot of time.
Here are some suggestions to pay off your debt faster:
Rather than paying off the low interest rate car loan first, it is wiser to pay off the credit card debt that has a higher interest rate. To do that, you have to make more than the minimum credit card payments. If the minimum payment is $80 then make an effort to pay at least $90. You probably won’t notice the extra $10 but it will go directly onto your principal and reduce your debt even faster. If you have three credit cards, it would be $30 extra payment, but the difference you will see in your total balance will be worth the effort. If you cannot do it at once for all your credit cards, start by paying off the smallest bill. The extra money that you will have from the paid off credit card can be used towards paying off the next smallest credit card bill. By paying more money than the minimum installments, you will lower your principal (original amount borrowed) at a faster rate. Consequently, the total annual amount paid interest will be reduced at a faster rate.
You can also quit using your credit cards and start using cash. By using cash for your transactions 1) you can control your finances because you know at any given time how much money you spend and how much money you have left in your wallet; 2) you don’t incur any hidden fees or over-the-limit charges, no billing mistakes or overcharges on your bank account; and 3) you can get discount for paying in cash. On the contrary, credit card debt builds up exponentially and interest rates can head up really quickly. Moreover, by charging smalls amounts of money to your credit card you add to your credit card bill and you lose track of your spending.
My Get Out-Of Debt Plan May Not Work For Your Situation
Each situation is unique and even if you carry the same amount of debt, it doesn’t mean that my get out-of-debt plan will certainly work for your case. However, I firmly believe that it can work as a guide to walk you through some vital steps that you need to take in order to understand exactly where you are today and most importantly, where you want to be in a few years from now.
Regardless if you follow my suggestions, or if you choose to follow some other solution, be disciplined. This is perhaps the most important step you need to take. By focusing on your financial independence you are more likely to achieve it. Without discipline, even the best financial plan will fail because every little amount of money you will be saving it will be spent towards non-essential purchases.
Every day we make decisions about money. And these decisions have a smaller or a greater impact on the quality of our lives. Being financially independent means different things to different people. To me, it means security, and the strength to take a step closer to my lifetime dreams. The steps to financial freedom may not give me immediate happiness, but they give me choice.
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