In 2010, my wife April and I were newly married and had a large amount of bad debt, mostly mine. We were making our minimum monthly payments, but it just didn’t seem like we were getting anywhere. We started paying just a little more than our minimum payments on our credit cards and our student loans, but it still didn’t seem like we were making a dent. Just like everyone else, we knew that we wanted to buy a home in the near future. However, to do that we needed to get our debt to income ratio under control. Unfortunately, what we were doing wasn’t doing it fast enough.
We decided to take a different approach and the formula we used accelerated our process in paying off our debt. I can tell you that if you follow these steps, you will find the same success as we did and be out of debt much quicker than you would expect. The key here is that you must stick to the formula.
Here is the 7 step formula that we followed:
- Make a List of all Your Bad Debt. This includes all of your credit cards, student loans, auto loans and any other consumer/bad debts that you have acquired. You may even want to include your home mortgage on this list as well, but that is optional.
- Next to Each Debt, Create 4 Columns. The four columns will be labeled, Interest Rate, Minimum Payment Due, Amount Owed and Number of Months to Pay Off. To get the number of months to pay off, just take the total amount due and divide it by the minimum amount due. So if you owe $4,670 and your minimum payment was $140, you would take 4670/140 = 33.4 months.
- Rank Each Debt by the Number of Months to Pay Off. Now that you have your list of bad debts, put them in order of the lowest number of months to the highest number of months to pay off the debt. The reason you rank the one with the lowest number of months is you get some quick wins, which will make you excited to take on the next steps.(Side Note: My wife and I modified this just a little bit, as we had a couple of extremely high interest rates on a few of our debts. So when we ranked them, we had 3 or 4 of the debts ranked by months and then we had a couple high interest debts, then back to the formula by month. We also had an interest free debt from my dad, so that was last on the list.)
- Find Some Extra Money. If you can generate $50 to $200 extra each month, you will find that it will help a lot. If you are really serious about getting out of debt and freeing yourself financially, it won’t be hard to do this. This could be going out and getting a part-time job or doing odd jobs for people. If you look for opportunities, you will find them.
- Minimum Amount Due on Each Debt. Now that you have each of the items ranked, and maybe a little extra money coming in (don’t wait to start these steps until you have the extra money), pay the minimum amount due on each of your debts, but add the extra money to the first item on your list. You will keep doing that until your first debt is paid off. Now cross that debt off of the list.
- Roll the Amount to the Next Debt. With your first debt paid off completely, continue paying the minimum amount on each of your debts except for item number two. Take the amount that you were paying on item one and roll it over to item two. So if your minimum payment on item #1 was $40 and you had added the extra $100, you would have been paying $140 toward item #1. Your minimum payment for item #2 is $55 plus the $140 for a total of $195 per month. After you have paid off each debt, roll the amount over to the next debt in addition to the minimum debt. When my wife and I started getting towards the end, we had over $1,400 rolling over and our debt was just melting away. We were completely debt free in less than one year. You will be amazed at how fast it will go.
- Pay Yourself. Now that you have paid off all of your bad consumer debt, you are going to pay yourself! Not that you are going to go out and spend this money on toys. You will take the money that has been rolling and build up an emergency fund. Start out with a 3-month emergency fund and build it up to a one year emergency fund. This will replace your credit cards from being your emergency fund going forward.
Bonus: One option that you may consider prior to really moving forward at full speed, is building up a $1,000 emergency fund. When I had done this exercise, I had found about two hundred dollars and put it into a savings account for a few months until we had $1,000. We already had about $500 in the account so it didn’t take long to get there. This fund is great to have in case you do have an emergency and it will prevent you from having to use your credit cards.
You may also find that when you start getting a lower balance due, your minimum payment will drop to a lower amount. Don’t be tempted to adjust the amount to the lower amount, keep the original minimum due. This process takes some will power, but I promise if you will just make a plan and stick to it, it will be extremely satisfying.
Question: I am interested to know of some of the things that you are doing or have done to get out of debt. You can leave a comment by clicking here.