How to get out of debt in 10 steps

I feel like this topic has been flogged to death but that’s because I’ve been blogging about money since 2006, so I understand that for newcomers this is totally overwhelming and confusing!

Here’s my 10-step plan for getting out of debt:

1. Find out how much you own (assets)
2. Find out how much you owe (debts)
3. Find out how much you make (net) as an income per month
4. Create a budget based on that (net) income
5. Track your daily expenses for at least 3 months against that budget
6. Set aside at least $50 – $100 a month for peace of mind
7. Stop using credit cards and use debit cards or cash instead
8. Review & adjust your budget each month
9. Put all your excess cash towards your debt
10. Clear off your highest-interest rate debt FIRST, then snowball the payments to the next

If any of that sounded confusing, read each step in detail below:

1. FIND OUT HOW MUCH YOU OWN (ASSETS)

What do you have in the bank?

Do you have a car?

A house?

What do you own?

Now that you know what you have in assets, or what you own, ask yourself if you need to keep them.

For instance, if you can take public transit because you’re lucky and live in a metropolitan city (even though taking the bus sucks and is gross to your psyche), you could easily sell your car and get rid of your car loan, car insurance payments, having to pay for parking, gas, etc.

Or if you have $5000 saved in a savings account but it’s only earning 0.25% interest compared to your credit card debt costing you 19% in interest each month, it’s pretty silly to keep that money in there.

Save $1000 aside for peace of mind and emergencies (and for goodness sake’s, move it into a high-interest savings account of at least 1%), and put the $4000 of savings towards your debts instead.

2. FIND OUT HOW MUCH YOU OWE (DEBTS)

This is the part where most people give up, but you can’t do this!

You need to figure out the final number of how much you owe.

Gather all your bank statements, write down the current balance and its interest rate in one big table, add it all up, sit back and take a Xanax as you stare at the number.

It might look something like this when you’re done:

After you know what you own and what you owe, take what you own and subtract what you owe to get your net worth.

This number will probably be depressing and demoralizing (don’t give up!), but it will be a huge motivator as you climb out of debt, so you might want to keep this figure in mind.

And maybe this quote in mind too:

3. FIND OUT HOW MUCH YOU MAKE AS A (NET) INCOME PER MONTH

Gross Income = What they offered you as a salary for the year (annually)

Net income = What you actually get in your pocket / bank each paycheque.

Take for instance someone who earns $40,000 a year on paper in Ontario, it looks like this:

$40,000 = Your Annual Gross Income

$5892 = Your Annual Taxes in Ontario for 2013

$34,108* = Your Annual Net Income

(*Gross Income minus Taxes = Net Income)

We are interested in the NET INCOME number of $34,108 because there are only 2 sure things in life: death and taxes.

That $34,108 is for the whole year, so now we divide it by 12 to get it by month:

$34,108 / 12 months = $2842.33 earned net per month

Write this down somewhere because this is what you should be using as income to budget for each month.

4. CREATE A BUDGET BASED ON THAT INCOME

Sticking with that $2842.33 per month your newly created budget might look something like this:

Still confused?

• Read: The Ideal Household Budget for Spending

If your confusion stems from not actually knowing what you DO spend each month, I bring you to step #5:

5. TRACK YOUR DAILY EXPENSES FOR AT LEAST 3 MONTHS AGAINST THAT BUDGET

You need a baseline of what you are actually spending versus what you think you are spending.

EVERYONE thinks that they spend less than what they think they’re spending.

EVERYONE. Including yours truly.

You think you’re only spending $50 on eating out?

Watch that number grow a fat 0 on its ass and you’ll freak out that it’s actually $500 a month because you go out for wings every Friday with the guys, but then you also buy lunches at work, or takeaway at night when you’re too tired (lazy?) to cook.

If you’re in debt, track your expenses until you are out of it completely.

If you are not in debt, track your expenses for 3 months and then stop doing it if you don’t want to (just re-visit once in a while to make sure you’re still in line).

• Read: Flip Flop Budgeting: For those who hate to budget

6. SET ASIDE AT LEAST $50 – $100 FOR PEACE OF MIND

If you are disciplined with your money already, I would tell you to save $0 and just dip back into your credit cards if you need cash.

However I am guessing you are not (yet) disciplined enough to do this because you are in debt and frustrated, scared, angry and confused right now so I suggest you save some money aside.

Now based on that budget above, the suggested 10% amount is $285. It’s a lot of money each month to save, while it sits there earning 0.25% interest in some crappy savings account.

You have 3 options for Savings here:

1. Continue saving that $285 a month because it makes you feel psychologically secure and feel better (don’t knock it!)

2. Get out of debt much sooner and only save $50 – $100 each month, while funneling the rest of that money towards your debt instead

3. Continue saving that $285 a month but stop once you reach a money threshold like $1000 or 3 months worth of living expenses in savings (in this case it would be around $8500).

Then stop saving that $285 a month and channel it towards your debt.

Whatever you decide to do, make sure it’s the right choice for you.

Ignore what other people say about how dumb it is to save money when you’re paying double-digit interest rates because having savings and not having to dip back into your credit cards can be something really quite empowering for some people.

Plus.. it stops you from being tempted to take out more than you actually need for your real emergency.

By the way an emergency is not that you had to pay rent that month, or you need to buy new winter tires, or you should be visiting a dentist once a year and it’ll cost you $200.

You should have already thought about that in your budget and planned for it ahead of time.

An emergency is..:

• You lost your job
• Your spouse lost their job and you can’t survive on one income
• You got into a car accident
• You lost your glasses / something important that you need to function / work on a daily basis with
• You lost your driver’s license and need to replace it

Emergencies are EXCEPTIONAL cases and EXCEPTIONAL situations; they are not recurring ones.

7. STOP USING CREDIT CARDS AND USE DEBIT CARDS OR CASH INSTEAD 

Again, if credit cards are your downfall, don’t use them.

As I mentioned above, if you are disciplined with your money you wouldn’t be reading this post. Since you are not disciplined (yet), avoid temptation as best you can and stop using your credit cards.

Do what you want with the cards — melt, burn, cut, ice them.. do what it takes to stop you from carrying one around and feeling tempted.

Until you can honestly trust yourself to use credit cards responsibly, don’t use them.

8. REVIEW & ADJUST YOUR BUDGET EACH MONTH 

Every month assuming you are tracking your expenses, look at where you went over or under in each category.

If you notice that you actually spend more money for utilities than you expected, either cut back in this area, or compensate by taking the money from elsewhere in your budget to make up for the shortfall (e.g. in more of the “want” categories like clothing, entertainment, eating out.)

Don’t get depressed if you slipped and spent more than $50 on eating out.

Just accept that you did it, and try to NOT do it the next month by packing your own lunch, saying “No” to dinners out, or going out with friends but only for drinks.

Changing your habits and your lifestyle is hard work.

It never came easy to me (still doesn’t), and I doubt it ever will to anyone.

If anyone says changing in any way shape or form is easy, they’re liars.

9. PUT ALL YOUR EXCESS CASH TOWARDS YOUR DEBT

Any tax refund you get, money you find on the ground, side income.. budget surplus .. PUT IT TOWARDS YOUR DEBT.

Don’t justify spending 50% of your tax refund on fun, and 50% on your debt.

Put 100% of it towards your debt.

I used to literally pick up coins (even pennies) off the ground, deposit them ASAP and then send a $0.10 payment towards my debt.

That is how seriously I took this rule.

10. CLEAR YOUR HIGHEST INTEREST DEBTS FIRST THEN SNOWBALL THE PAYMENTS TO THE NEXT

It goes without saying that you should pay the minimums on all of your debts, and then put the excess money towards the highest-interest debt.

As an example here are what your debts might look like:

In the budget above, you had $525 to put towards debt each month:

 

After paying the minimum pound of flesh required by each creditor, you are left with $105 in excess.

Put it towards the debt with the highest interest rate, which in this case is Credit Card #1

 

*$130 + $105 = $235

You might be tempted to put it towards the lowest balance like Credit Card #2, but you are paying a LOWER interest rate of 19% on that card versus 25% but don’t do it!

It might feel satisfying to have it paid off completely but you’d be losing 6%* of your money each month if you did that.

(*25% – 19% = 6%)

After that credit card #1 is cleared your next step (snowballing) would look like this:

 

*$235 + $65 = $300

You would have taken that original $235 payment you made to Credit Card #1 and put it towards Credit Card #2, your second highest interest debt rate.

Now you’re paying $300 a month on a $65 minimum dollar balance.

After you’re cleared THAT card, move on to the third highest interest rate of 12% (your line of credit) and clear that next.

Wash, rinse, and repeat until you’re debt free.

And that’s how it’s done.