Getting out of debt requires the same mindset as losing weight or trying to quit smoking. You have to change your underlying behavior. First put out the fire, so to speak, before you try to rebuild your house. Once you realize how you got into debt, you can begin to develop a strategy to get yourself out of it.
Credit Cards
Stop using your credit cards. Make all your purchases with cash or a debit card until you pay off your credit card balances. If you have balances on more than one credit card, pick one to pay off first. Some people prefer to pay off the card with the highest interest rate first, while others choose to pay off the card with the smallest balance first. The first method saves you money by getting rid of a high-interest card. The second method gives you a feeling of victory that could help keep you going. After you pay off a card, don't close your account, just put the card away, and work on paying the next card. Keeping your credit cards open and maintaining an available balance helps your credit score. Pay more than the minimum balance on the card you are actively paying off, and continue to pay the minimum on any other cards.
Other Debt
Tackle your other debt, such as car, furniture and student loans. When you buy a new car, for example, and the salesman talks about the low monthly payments, understand that what really is happening is the lender is making a killing on the loan in the interest you pay. If the only way you can afford a car is by making the payments stretch five years or more, you are probably spending too much. The exception to this is your mortgage because the interest you pay on mortgage loans is typically lower than interest you pay on other types of loans, and you can deduct mortgage interest on your income tax. Rather than using extra money to pay off your mortgage sooner, it might make more sense to invest that money. If you do want to pay the mortgage off sooner, the best way is to increase each monthly payment by one-twelfth, the equivalent of making one extra mortgage payment per year.
Retirement
If you carry credit card debt and you contribute to a retirement fund, such as a Roth IRA, you might want to stop contributions to the IRA until you pay off your credit card debt, especially if your interest rate on the card is more than the interest you earn on your Roth. If you contribute to a 401(k), the same advice applies, unless your company matches funds. In that case, you might want to keep contributing to your 401(k) to get matching funds, even while you have credit card debt.
Make a Budget
Make a budget to prevent you from getting into debt trouble again. Harvard law professor and bankruptcy expert Elizabeth Warren suggests using the 50/30/20 budget, no matter your income level. Take your after-tax income, and limit your "must have" purchases to 50 percent of that figure. Must have purchases include your mortgage, utilities, food, transportation, insurance, childcare and minimum loan payments. Going out to eat or buying a new outfit are not must have items. Your wants are 30 percent. Entertainment, clothes, vacations and dining out are wants. The 20 percent is for debt repayment and savings. Warren admits that while this plan may look easy on paper, it can be difficult to achieve. When Warren tried this exercise herself, even though she has a generous income and no debt, her must-haves were 60 percent of her after-tax income. It took her a year to get that figure down to 50 percent.
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