Editor's note: This article was originally published on Anita Fowler's blog, Live Like You Are Rich. It has been republished here with permission.
Most Americans are in quite a bit of consumer debt. Consumer debt (also known as bad debt) is accrued by purchasing items that you don't have the money to pay for. Living a rich life (materially and non-materially) requires that you have financial peace of mind. Financial peace of mind cannot come when you don't have enough to pay the bills and are consistently racking up debt. It comes through discipline. spending less than you make, getting out of debt, and setting excess money aside for security purposes.
How to Get Out of Debt
1- Avoid adding to the debt
Just as the first step in stopping a sinking boat is to plug the hole where the water is leaking in, the first way to get out of debt is to avoid adding more to it.
2- Itemize your debts from lowest to highest amounts (first by the amount of the debt owed, and then by the interest rate).
The reason for this is that the smallest loan(s) can usually be paid off quickly. If you can get rid of a few of the debts that are smaller (even if they have low interest rates) quickly it will boost your confidence and help keep you going.
Often people pay the highest interest rate off first. But if you have a furniture loan of $700 with a 7 percent loan and a credit card of $10,000 at a 14 percent loan even though the credit card has the higher interest rate, it is best psychologically to pay the furniture loan off first and have one less debt to worry about. Then move onto the credit card.
The exception to this is if the loans are very close in amount owed and the interest rate is very different. Take for example the same credit card of $10,000 with a 14 percent interest rate and a car loan of $9,000 with a 4 percent interest rate. You will want to pay off the credit card before the car loan to save money in interest. The way to stack and pay off the debts is of course up to you. The most important part is having an order in which you will pay them off and a solid plan.
Example: Jack and Jill's Debt Payoff Plan:
Debt 1: Furniture - $700, Interest rate - 7 percent, Min. Payment - $100/mon.
Debt 2: Credit Card - $10,000, Interest Rate - 14 percent, Min. Payment - $75/mon.
Debt 3: Car - $9,000, Interest Rate - 4 percent, Min. Payment - $350/mon.
Debt 4: Mortgage - $150,000, Interest Rate - 4.5 percent, Min. Payment - $1,000/mon.
3 - Now once one debt is paid off you take the payment you were making monthly to that debt and apply it to the next debt on the list.
So if the furniture payment was $100/month then you would take the $100 a month and apply it to the credit card (or the next debt in line to be paid off). If the credit card payment was $75 a month you are now paying $175 a month toward the balance. Once the credit card is paid off you will move that $175 to the next debt on the list, the $9,000 car loan. The car loan was $350/month and you've added the $175 to it, so now you are now paying $525/month toward the car. Once the car is paid off you would apply the $525 to the next debt. Say it is the home mortgage of $150,000, with a monthly payment of $1,000 and interest rate of 4.5 percent, you will now be paying $1,525/month to your home and will save considerably in interest!
After you are finished paying off your debts in this manner you will realize that you have paid them much faster than the minimum payments were designed for. Therefore, not only did you save in interest but if you reinvest the $1,525 payment you've been making monthly into something like an investment insurance policy, a real estate fix and flip property, or a business venture, you will have made additional money in the same time you would have originally been in debt!
IMPORTANT: Whenever you apply any additional funds to a loan in most all cases you must SPECIFY to the bank or to the loan company that the additional funds you are paying MUST be applied to the principle and not to the interest. If you do not specify this the bank will typically act as if you are paying for the payment one month early and will force you to pay interest with those additional funds.
4 - How to get out of debt even faster?
If you can free up funds by learning how to save money, or if you can make additional money, and cut expenses you will get out of debt much faster!
5 - Go over your plan and recommit yourself (and spouse/family) at least once a month
I found that the more I looked at my plan when we were getting out of debt the more resolved I was to not overspend or get off track. Consistency is probably the most important steps.
Important Life Changing Bonus Tip
Once you have paid off your debt, take the payment you were making each month to the last debt on the list and reinvest it. A wise man once said, "There are two types of people in this world, those who pay interest and those who earn it." When you are out of debt you can start earning interest. Albert Einstein said that compound interest is the most powerful force in the universe. So take that same money you were paying on your debt and save and grow it in a _wise_ investment.
The quicker you can get out of debt the more money you will save because it costs money in interest to owe money. Take these five steps, stay consistent and you will get out of debt sooner than you ever thought possible!
