How to Get Out of Debt: 5 Steps to Healthier Money Habits

How to get out of debt:

Step 1. Pay off all your outstanding bills. The end.

It seems like a pretty easy bit of advice, really. To get out of debt, pay off all your bills. That is great advice for a lottery winner, but it just isn’t that easy if you don’t have that recent windfall.

Depending on the amount of your debt, it can be soul-crushing. Making the minimum payments doesn’t seem to get you anywhere—sort of like walking backward on the people-mover at the airport.

The debt seems to follow you everywhere. You can never stop thinking about it. And forget about investing… how are you ever going to get a loan with all those outstanding bills?

The first step to getting out of debt is understanding why you are in debt. Most debt is avoidable.

No, not all debt is. Emergency medical bills can be outrageous and difficult to plan for. I had my appendix out 20 years ago. I woke up fine one morning, and by 2 a.m. the next day, I was in an operating theatre, having major surgery. It cost more than $14,000.

Not exactly small change you can just find in the couch.

One good note is that hospitals understand they are ridiculously priced and will typically work with you on a payment plan so your medical charges are more manageable. When I had my second daughter, her hospital bill arrived right around a fairly tight spot in the month for us. I called the hospital’s billing department, hoping to be able to pay 50 percent of the bill that month and the remainder the next month.

Before I could even ask about specific terms, they offered me the option of paying it over 11 months and said if I needed more time than that, I would have to talk to a supervisor. I happily grabbed those 11 months before she could ask me what I had in mind.

But medical debt isn’t the focus of this article. Yes, it can be difficult to get out from under the pile of medical debt, but as long as you are making regular payments, it won’t be reported to the credit bureaus. Medical debt is some of the least damaging.

No, the focus of this article is your other debt. The damaging debt. The credit card debt.

Medical debt can be paid off in much the same way as your other debt, but since it isn’t as detrimental to your credit score, let’s prioritize it to the bottom of the list. Continue making the minimum payments, but try not to get bogged down with the total amount just now.

How to Get Out of Debt

1. Track Your Spending

If you want to know how to get out of debt, first you need to know how you got into debt. Do you know where your money currently goes?

I have found the easiest way to know how you are spending your money is to track every dime. It’s so easy to forget $6.95 for lunch or $5 for an after-work drink by the time the end of the month rolls around. It is pretty difficult to contest if it’s written down in black and white.

I keep track of When, Where, How Much, What I Bought, and a Running Total of how much I have spent that month so far. It’s easy to do—I keep the notebook right on the kitchen island where I enter the house, next to where I put my keys. It’s the first thing I do when I come inside; I write down what I just bought.

It only takes a minute. I use a notebook to do this, but if you prefer electronic record-keeping, Mint has a great program to keep track of spending, make a budget, keep tabs on your credit score, and pay bills. Best of all, the program is absolutely free.

This simple method showed me that I was going to the grocery store nearly every single day when I first started keeping track. Holy cow! No one needs to go to the store every day. But I was going without a list and “just running in for a couple of things.”

The problem with that is you almost never leave the store with just the items you went in for. No, you remember this one other thing, or see that item in the clearance aisle, or your kids ask for a treat and before you know it, one item becomes 10. Multiply that with an everyday trip, and, well, you can do the math…

Your spending issues may be different. Perhaps you’re spending more on clothes or shoes. Once you have all your spending tracked, look for trends. Money on non-necessities can and should be cut back until your debt is paid off.

2. Make a Budget

After you know how much you are spending, analyze where your money is going. Every dollar should have a purpose, and your absolutes should come first. Housing, utilities, and food should be the first items in your budget, and they should be fairly fixed.

Rent or mortgage payments are the same each month. Easy to budget for.

Many utility companies have budget plans that take your past usage and average it out over the year, so you pay a set fee every month. This helps avoid seasonal usage spikes that can wreck a carefully planned budget.

Your food budget is where you can probably cut back the most and feel it the least. Chances are good that you are going out for meals and spending too much on unnecessary food items at the grocery store. If you are truly serious about paying off your debt, cut back on or entirely cut out restaurants.

Meal planning is a huge help in cutting out food costs. It also helps you plan your grocery lists, so you make fewer trips to the store for missing ingredients.

Staying connected to friends while trying to pay down debt can seem like a lost cause—they want to go out to movies, restaurants, and concerts, but you need to use that money more wisely. Host a potluck dinner, have a game night, check out the free events in your city, or go for a hike. If you are creative, you can find a lot of ways to have fun with friends that don’t involve spending lots of money.

3. Dump That Debt

There are two main thoughts on tackling debt. Either do the Dave Ramsey Debt Snowball approach, or start with the most expensive debt and work your way down. Both have their pros and cons.

Smallest to Largest

Dave Ramsey is a financial author, radio host, and motivational speaker, who answered the question of how to get out of debt with a strategy called the Debt Snowball.

You write down all your debts, from the smallest dollar amount to the largest dollar amount, regardless of interest rate. You make the minimum payments on all debt and make as high an extra payment on the smallest debt as you can possibly make. Ideally, you give up all extras and luxuries, and you throw every extra dollar you have at your debt.

When the smallest debt is paid off, you get to cross it off your list and start attacking the next smallest debt using the money you were using for the now paid-off first debt and throwing it at the new debt target.

The theory behind this approach is that if you keep doing what you were doing, you will continue to get the same results. It isn’t very motivational to see piles and piles of debt all the time, seemingly not getting any smaller. But paying off that first debt can be very inspirational—and it will show you that you CAN succeed at getting rid of it once and for all.

Highest Interest Rate First

An argument against the Debt Snowball approach is that you are not necessarily paying off the debt with the highest interest rate first and may end up spending more money on interest. It makes more financial sense to pay off the $10,000 at 18% interest, rather than the $5,000 at 4% interest.

But Dave Ramsey himself said:

“That is a math solution. This isn’t a math problem, this is a behavior problem. You fix a behavior problem with a behavior-based solution.”

I can see both sides. And having a win by erasing an entire debt using the Debt Snowball method can be the impetus to keep you going.

Hybrid Solution

The psychological impact of removing a debt from your list can be what keeps you going, but paying all that extra interest isn’t to your advantage. Perhaps a hybrid solution would work best for you.

Pay off the lowest dollar amount debt first, so you have the success story to think about, then tackle the debt with the highest interest rate next. Switch back to the next lowest debt for another boost to your financial confidence, then jump on top of the next highest interest debt.

Flip back and forth to keep yourself motivated by the wins, while working on paying off the highest interest rate debt to pay the lowest amount of interest possible.

4. Reduce the Interest Rate

In the past, it was possible to call up your credit card company and request a lower interest rate. The card companies aren’t so eager to comply with these requests any longer, and they really don’t have to be.

That doesn’t mean you shouldn’t ask, especially if you have an exorbitant rate. But don’t be surprised if they refuse to lower it.

If you get turned down, start looking for another card with a lower rate, even if the rate is only introductory. Take into account any balance transfer fees the new card could charge. A typical balance transfer fee is around 3 percent. That could be a bit steep if you have a large balance to transfer, but if your current balance is 18 percent interest, it may work to your favor to pay the fee.

It is getting harder to find a card that offers a 0 percent balance transfer fee, but they are still out there.

Don’t forget to cancel the original credit card after you transfer the balance so your available credit doesn’t tip your credit score in the wrong direction. However, if the card that had the original balance was the first major credit card you ever opened, consider keeping it open. It establishes the length of your credit history, and you want as long a credit history as possible.

To keep your credit availability down, call the card issuer and ask for a reduction in your credit limit.

5. Add Some Extra Income

OK, so you have committed to getting out of debt, you tracked your spending, put yourself on a budget, and removed all the “extras.” There is still more you can do.

Look for additional sources of income. The more money you have to throw at that debt, the faster it will be paid off. The blog called BudgetsAreSexy has a Side Hustle Series filled with creative ways to make extra money—and these side jobs are all over the board with various time requirements and necessary skills.

Did you get a raise last year? Continue living off the lower salary and throw all the extra into paying off your debt. Did you receive any bonuses? Same deal applies. Live day to day as though nothing changed, and put the extra cash into paying down your total.

I was fortunate to not have to take out any student loans, but my husband was not so lucky. I still remember the day we wrote the final check to pay off his student loan. It was so liberating to finally be out of debt. I could actually feel the weight lifting off my shoulders.

Keys to Success

You can find many ways to reduce your expenses during your debt repayment. Creativity and commitment are the two keys to your success. Unavoidable expenses may pop up during your debt repayment.

It will take time to pay off. But keeping your mind on the freedom that comes from being debt-free will make the journey easier.

Have you paid off a large amount of debt? How much did you pay off? How did you do it?

Be sure to leave your questions and comments below!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.