Has the new year motivated you to start chipping away at your debt—but left you wondering where to begin? In this ongoing series on how to get out of debt, you’ll be introduced to the very first steps to take in order to make your dreams of eliminating your debt in 2012 a reality.
The key to getting out of debt is first knowing exactly how much you owe. It sounds basic, but most people who have debt feel overwhelmed by the idea. As a result, they go through the motions of debt management, and pay the minimum amount required on monthly bills. This strategy will keep your “head above water”—but it never truly leads to a zero balance and financial freedom. (It also costs a lot of wasted money on interest rate payments). In order to get out of debt, you need a plan and a defined “exit strategy.” It all starts with facing your fears and figuring the total debt you owe.
GET OUT OF DEBT STEP 1: Compile your bills
Gather every single statement you have for revolving debt, including credit cards, personal loans, car loans/leases, and student loans. Make a list (either on a sheet of paper, or electronically) with five columns and these headers:
- The creditor name and payment address
- Total amount due on the loan
- The minimum payment due
- Payment due date
- Interest rate on the loan
- *If you have 0% interest rate loans, add another column and note the date that introductory rate will end—and what the interest rate will increase to.
Sort the list from highest interest rate to lowest.
Add the total amount of the balances. This is your total debt. (Don’t worry, we’ll break it into manageable chunks)!
GET OUT OF DEBT STEP 2: Calculate your income and expenses
On a separate list, write down your monthly income, after taxes and insurance. (If you have no idea, look at your bank statements or pay stubs. Don’t estimate or guess).
Next, take account of your expenses:
- Look at your most recent bank statement and itemize your fixed monthly expenses, not including your credit card or loan payments. This list will include expenses that don’t change from month to month, like rent/mortgage, utilities, cell phone, gas, groceries, gym memberships and insurance that is not taken out of your paycheck (like renter’s, homeowner’s or car insurance).
- Create a “total fixed monthly expenses” line, and add them all up.
- Next, itemize your monthly miscellaneous expenses, like dining out, entertainment, gifts, shopping, “one-off” grocery trips, etc. If you’re not a budgeter, most people’s expenses in these categories vary significantly from month to month, so try to arrive at some “historical average” by looking at your receipts, credit card statements and bank statements, for at least the past three months. It may be helpful to take advantage of free online budgeting tools offered at sites like Mint.com, which can track these expenses for you.
- Add these miscellaneous monthly expenses to arrive at a total. Add it to your “monthly fixed expenses” total, to calculate your “total monthly expenses.”
GET OUT OF DEBT STEP 3: Calculate what you can put towards debt
Subtract “total monthly expenses” from “total monthly income.” This is the amount that you have to work with in chipping away at debt. We’ll call it your “Freedom Fund.”
These first steps will help you to take account of the nature of your debt and spending habits so that you get a realistic picture of what can otherwise be overwhelming and difficult to visualize. Stay tuned for Part 2 to learn more about how to chip away at your debt in the new year!