Author: David Wright
Here are 11 steps that can help you become debt free:
1. Get motivated
Money stress might be affecting your health and limiting your ability to think clearly. Make a commitment to change your life.
2. Choose a reward for getting out of debt
Place a photo of your chosen reward on your refrigerator door. You need to have something to look forward to that spurs you on and gets you excited. But be reasonable, don’t choose a reward that’s likely to set you back into debt!
3. Get a buddy
Motivation is always harder to muster on your own. So ask a close friend, a family member or someone else who fits the bill to have weekly check-ins with you to give you some accountability on how you’re tracking.
4. Set up an emergency fund
Having even $1000 stashed away can reduce your reliance on credit if unexpected expenses pop up. Once your emergency fund is in place, you should then consider cutting up your credit cards and reducing their limits as you pay them off. Once you’ve cleared your credit card debt, only shop with cash or a debit card.
5. Create a list of all your debts
Sit down and draw up a complete list (or, even better, a spreadsheet) of all your debts, include:
- Details about who you owe money to
- What the money was spent on
- The amount you owe
- Current repayment amounts
- Interest rate
- Final payment date
This will help you know where you stand, so you can then take the following steps to help clear your debts:
6. Negotiate your repayments
Visit or phone your lending institutions and say that you’re looking for a better deal, and ask what they can offer you. If you’re not happy with their response, simply say that you’re thinking of paying off and closing your loan or credit card account(s). Do this and, most likely, they’ll start offering you a better deal.
However, if you’re experiencing financial difficulty, then be upfront about it, as your lender may be able to offer you some respite. You may be able to negotiate repayment plans with lower interest rates and repayment amounts.
7. Consider consolidating your debts
Where appropriate, consider consolidating multiple smaller high-interest rate debts into one larger low-interest rate loan. This may be a personal loan or your home loan.
You may consider applying for a 0% credit card balance transfer offer to save interest. Most banks offer these, but be aware that all applications for credit are listed on your credit history and impact your credit score.
Update your list of debts if you have finished this step.
If you’re thinking about consolidating your debt onto your home loan, you can view a snapshot of home loans currently available in the market for refinancing in the table below. Please note that this table has been generated based on a two-year fixed residential rate for $500,000 in Auckland, and is sorted by current rate (lowest to highest). If you’re interested in comparing for other regions, or loan amounts, check out the home loans comparison tool here.
8. Look for ways to cut back costs
Negotiate better deals on essential services, such as your phone and electricity. Also think about how you may be able to reduce other costs, for example cancel subscriptions that are non-essential, such as Netflix, NEON or Spotify, for example.
9. Automate your recovery
Now you have reduced your outflows as much as possible, make your recovery happen automatically and easily. Factor your debt repayments into your budget as an expense that you need to put aside each time you get paid. Set up a new separate bank account for your bills and outgoings, and transfer money automatically each payday.
10. Try to make some extra cash
Consider selling possessions you no longer need or use. Even if you sell something at a loss, it’s not uncommon to make money in saved interest in the long run. Put the proceeds from what you sell towards paying off your highest interest rate debt.
Also look for opportunities to generate more income. Some ideas include taking in a boarder, working extra hours or shifts, looking for a second job, or even making jams or preserves to sell at a local market. Get creative and you could increase your income.
11. Make a debt repayment plan
Two common repayment plans are often recommended: the snowball and the avalanche. Let’s take a look at how these work.
With the snowball method, you pour any surplus cash into paying off your smallest debt first. Then, when that debt is paid off, add (or snowball) that repayment onto the next smallest debt until it’s also paid off. Continue this process, always adding the repayments from the paid-off debts to the next smallest debt until all debts are cleared.
This involves pouring any surplus cash into paying off your highest interest rate debt first. When you’ve paid off that debt, add that repayment onto the next highest interest rate debt until it’s also paid off. Continue this process, always adding the repayments from the paid-off loans to the next highest interest rate loans until your debt repayment is complete.
These two methods look very similar. The point of difference between the two is whether you tackle the smallest debt first, or the highest interest rate debt first.
Mathematically, tackling the highest interest rate debt first will save you more money, so the avalanche method is a better option financially. However, the snowball method has emotional benefits that some feel outweigh the financial benefits, i.e. quickly seeing the number of your creditors diminish.
However, whichever method you choose, it’s important to do something special each time you achieve a goal (such as paying off a debt). So, in the month after a debt is paid off, you might want to take some of the repayment money that is spare to reward yourself. But be sure to then add the full amount to your highest interest rate debt repayment thereafter.