How to Get Out of Debt and Stay Out of Debt

stay out of debt

In total, American households owe approximately $13.67 trillion in debt. On average, each American owes about $63,000. The debts cover a range of categories, including mortgages, student loans, credit cards, auto loans, and medical debt. To make matters worse, many people don’t know if they’ll ever free themselves from debt. However, by taking the right steps, it is possible to get out of debt for good. If you want to become debt-free, here are some tips to help you achieve your goal.

Know Your Situation

When it comes to dealing with debt, denial is the enemy. Being ignorant about your financial situation – either intentionally or unintentionally – is only going to make debt harder to conquer. This is especially true if you aren’t the only person who can use a credit account, as being unaware of the actions of other parties could allow the situation to get worse undetected.

You should also get free copies of your credit reports from AnnualCreditReport.com. That site is supported by the government and gives you a way to see what creditors are on your reports. This ensures you don’t miss an account when creating your list and gives you a chance to spot potentially fraudulent activity that might be hurting your credit scores.

While facing your financial state might not be fun, it is necessary. By fully understanding where you stand, you can make a plan to eliminate your debt and prevent it from recurring.

Write It Down

If you really want to keep tabs on your debt, you need to write it down. Create a list of all of your accounts, including the lender’s name, current balance, interest rate, and minimum payment. If you are behind on a bill, also note how many months you’ve missed.

Next, create a list of all of your monthly income. You may want to focus on your net income (the amount you take home) as this will be more helpful for budgeting.

Then, record any additional recurring expenses. For example, write down your utility payments, insurances, grocery spending, and every other spending category that reflects a necessary expenditure.

Once you have that all collected, you can use it to create an initial budget. The hope is that your income covers all of your debt payments and other expenses, with a bit of room to spare. If not, then you need to look at scaling back your spending or options for increasing your income.

Negotiate Your Debts

In some cases, you can negotiate lower interest rates and even debt principals. If you are struggling with high-interest debt, have a good credit score, and haven’t missed any payments, your lender might be willing to reduce your interest rate. If you land a lower rate, update your list accordingly.

At times, if you can offer a substantial lump sum payment, your lender may accept that money and forgive any remaining debt. Let them know how much you can provide. If they accept, get a formal commitment in writing to honor the agreement from the company, and then send the payment.

Settling the debt can help you save. However, it may come with some tax implications. At the end of the tax season, the lender might issue a 1099-C (cancellation of debt tax notice). When this occurs, you will be taxed on the difference between what you paid and what you owed as if that amount was income. IRS Topic No. 431 covers the topic in more detail, allowing you to see how it might affect your income taxes.

Craft a Household Budget

With all of the information ready, you can create a budget. List your debts and your must-handle expenses, like insurance and utilities. Then, add in flexible categories that don’t require a set amount of money, like groceries and gasoline for your car.

If your expenses exceed your income, make some cuts. See if you can eliminate or reduce some of your bills, particularly those tied to entertainment like cable and streaming services. Then, pare down other flexible categories, like your food budget. While you might be living a bit uncomfortably for a while, it gives you more room to conquer your debt.

Create a Debt Repayment Strategy

Once you know how much money you have beyond your debt payments and expenses, it’s time to create a payoff strategy. There are two popular approaches that can be great places to start if you aren’t sure how to begin.

The debt snowball strategy, made famous by personal finance expert Dave Ramsey involves putting all of your extra cash toward your debt with the lowest balance. This gives you a quick win, which can be motivating. Then, once that one is paid off, put all of that payment to the new lowest balance debt, continuing the process until everything is paid off.

Alternatively, the debt avalanche uses a similar methodology, but you concentrate on the highest interest rate debt first. You might not get a win as quickly, but this option saves you the most money by having you pay less in interest over the course of the process.

If you don’t have an emergency fund, you might want to build that up first. Even $1,000 in savings can help you avoid having to add new debt, giving you a cushion for emergencies.

Follow Your Strategy

After getting your debt repayment strategy outlined, follow it diligently. While it takes time, the above approaches do work. If you need something to keep yourself motivated, consider creating a visual aid, like a debt payoff thermometer, so you can see your progress with ease.

Staying Out of Debt

Once you conquer your debt, you want to make sure you don’t fall back into old habits. Embrace a frugal, cash-based lifestyle, and focus some of the money you freed up on building your savings.

With a large savings cushion, you can make large purchases in cash or handle emergencies. Plus, you’ll be shielding yourself against the unexpected, such as a sudden job loss or medical emergency.

After gathering three to six months of living expenses in an emergency fund, you can start exploring ways to make your money work for you. Fund your retirement, start investing, and use dedicated high-interest savings accounts to handle upcoming costs.

At this point, the goal should be to ensure your financial well-being today and in the future. With ample savings, you won’t have to turn to debt to handle the unexpected or large planned purchases, allowing you to avoid debt with greater ease.

 

Do you have any tips for getting out of debt? Share your thoughts in the comments below.

 

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