Getting out of debt is not easy, but if you don’t keep debt in check it will bury you. Making the decision to reduce your debt is the first step, but the execution part will require a lot of willpower. The good news is that paying off debt is not only good for your financial health but also good for your mental health. Paying off debts tends to relieve a lot of mental stress, and it can leave you with a feeling of accomplishment. In addition, money is consistently one of top reasons for marital problems. In today’s post we will discuss several different strategies to reduce and/or eliminate debts. I recommend following the steps below in order when getting out of debt.
1. Establish an Emergency Fund
Before taking on your debts build a small emergency fund first; this will keep you from going deeper into debt if something unexpected happens. You might be tempted to use credit cards, but turning to credit cards for emergencies is not the way to go; you want to get out of debt, not add more. Plus, once you start paying down debt it can be demotivating to have to stop because an emergency came up. I recommend saving at least $1,000 in an emergency fund before turning your attention to debts
2. Determine your Debt Situation
Before you start attacking debts you need to know what you are dealing with. If you have been following the basic finance posts then you likely already know what debts you have; if not I encourage you to take a look at the budget post and set up your own budget. It is important to know what the amount of each debt is and what the interest rate is. If you would like a metric to track progress you can use either your total debt over time or your debt to income ratio over time. Debt to income ratio is just how much debt you have divided by your gross yearly income. If you have $75,000 in debt and make $50,000 per year gross your debt to income ratio is 1.5.
3. Be Honest with Yourself
If you have your budget and established an emergency fund take a moment to think about how you got into debt. Like most bad habits financially destructive habits are easy to acquire and hard to let go. Be honest about how you got into debt, and if necessary make a commitment to change your behavior. If you are spending less than you earn then you are on the right path. If you have a weakness for credit cards then stop using them while trying to get out of debt. You don’t have to necessarily cut them up, but don’t carry them with you; use cash as often as possible.
If you need help talk to your command financial specialist, check out your local financial support center on base, or go online to MilitaryOneSource. Dave Ramsey is a well known financial coach and I like his methods; his quote below is worth keeping mind when getting out of debt.
4. Start with Interest Rates
Before you pick a debt to go after start by trying to reduce interest rates first; this won’t cost you anything. Explore lowering the interest rates on your credit cards by calling the company and asking, the worst they will do is say no. Also explore the possibility of refinancing your auto loan for lower interest.
One tremendous perk of being active duty is the Servicemembers Civil Relief Act (SCRA). The SCRA offers the following major provisions:
- Limits interest on all loans taken out before joining the military to 6 percent. This includes auto loans, mortgages, student loans, credit cards, etc.
- Lets you end a vehicle lease you signed before joining if you are mobilized, PCS OCONUS, or deploy OCONUS for at least 180 days
- Lets you end a housing lease without penalty if you deploy for 90 days or more
- If you use any of your SCRA rights and delay payments it won’t reflect on your credit report
- Prevents your landlord from evicting you unless the rent is higher than $3,451.20 per month (this amount changes every year)
- Stops foreclosures without a court order
These are not all of the SCRA benefits; for more information see the official website: SCRA
I strongly encourage you to explore the SCRA benefits and see if any can assist you with your debts.
5. Explore Additional Options
After trying to lower interest rates if you feel you need more help investigate relief societies, balance transfers for credit cards, and consolidation loans. The local military relief group, such as Navy-Marine Corps Relief Society, may be able to offer you a loan with a low interest rate.
Balances transfers allow you to open a new credit card with a very low (normally 0%) interest rate and transfer your other credit card debt to the new card. I have seen balance transfer offers of 0% interest for up to 24 months. If you are considering this make sure you can pay off all the debt in the time period; after the 0% period is over the interest rates go up drastically. A balance transfer may be worth looking into, but the key to making it work in your favor is to pay off the entire balance during the 0% time period.
If you are struggling with major credit card debt it may be worth considering a consolidation or personal loan to lump all your debts into one monthly payment. With this option you would take out a loan to pay off all your debts, then you owe only on the consolidation loan. If you go this route make sure you get a loan from a reliable source and understand completely what you are getting into.
6. Pick a Debt to Pay Off
After lowering interest rates you need to pick a debt to go after. There are 2 ways to go about this:
- Choose the debt with the highest interest rate and pay that off first
- Choose the lowest dollar amount debt and pay that off
Examine all your debts and their respective interest rates, then choose one that will provide the greatest benefit to you based on the criteria above. Being a math guy I like to hit the highest interest rate debt first since that is what is costing me the most money. However, you know yourself best. If you want to build some momentum then go ahead and pay off the smallest debt first, this can build your confidence.
7. Pay as Much as Possible
Here is where the effort of budgeting pays off. Each month put as much extra money as you can toward paying down the chosen debt. Now, I am not saying live of Ramen noodles every day, but if your budget reveals you have an extra $150 each month then put all $150 toward the debt. Don’t lose focus and spend that $150 on something you don’t need. Tackle your debt aggressively, keep your momentum, and before you know it it’s paid off.
8. Move onto the Next Debt
Congratulations on paying off a debt; feels good doesn’t it? Remember the feeling, pick another debt and hit it hard!
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