If you want to get out of debt on your own (and quickly), I’ve got the post that will help you do it.
Not someday. Not tomorrow. Right. Freaking. Now.
Get your boots on.
Warning: There’s a lot of information here. I tried to make it as skimmable as possible, but you can jump to sections like the three prerequisites to permanently ridding yourself of debt, how to calculate your Debt Ratio, or the debt toolbox which shows you how to use things like balance transfers and social lending to get out of debt faster.
I’VE BEEN THERE
If you’re new to Money Under 30, let me catch you up on my story.
I was a debt junkie for almost ten years. I ran up credit card after credit card living like my salary was about four times its actual size. Stupid things I bought on credit included flying lessons, weekends in Vegas, and a spanking new pickup truck. Hey, I never said I wasn’t having fun. (Remember, I’m on the other side of 25 now, so I started college pre-recession… during the dot-com boom. Back then, I actually thought I could graduate with a sociology major into $75k a year job—because I knew people who did!!!)
We all know that didn’t’ happen, and soon enough, the debt caught up with me. Around the ages of 25-26, I maxed out with debt of around $80k. All of a sudden, I couldn’t keep borrowing my way out of trouble anymore. At the same time, I realized that the stress of barely making my monthly payments and owing twice what I earned in a year was taking its toll. I was, to quote my bio, “maxed out, stressed out, and fed up.”
So I decided to change.
I’m a smart guy. And I don’t consider myself afraid of a little hard work. So several years ago, I resolved to:
- Get out of consumer debt on my own.
- Go a step further and achieve a kind of financial stability that most people never do.
- Blog about it in a way that makes it accessible to others.
(And here we are.)
Today, I have no consumer debt. By choice, I’m not debt-free. For example, I’ve chosen not to pay off early two student loans totaling about $4k because they’re at interest rates of three and five percent. (To learn why, read my recent post on when paying off student loans early makes sense and when it doesn’t.) I also recently bought a home with a 20-year fixed rate mortgage. In these cases, I’m using debt conservatively and consciously to advance my financial goals. But all the nasty stuff—credit cards, personal loans, and an auto loan—is long gone.
I blog because I want to help you get a hold of your finances and get them to a place where you can stop worrying about money and get on with life.
Contrary to what hundreds of marketers and self-described personal finance “experts” will try to sell you—there is no secret to getting out of debt. No right way. No silver bullet.
That said, I think it IS fair to say there are a few requirements to permanently ridding yourself of consumer debt.
- You must confront your debt.
- You must permanently change the behaviors that got you into debt.
- You must make enough money to repay the debt.
Throughout all the years I carried this debt around with me, I never wanted to be in debt. But it wasn’t until I met the three criteria above that I was able to do something about it. First, I had to stop living in denial, telling myself my debt “wasn’t that bad”. I needed a reality check and to stare down exactly how much debt I had and what it would take to get out.
Second, I needed to figure out why I was in debt and STOP DOING THOSE THINGS. I had to tone down my lifestyle. By a lot.
Finally, I had to find a way to earn enough to repay the debt. So I got a second job, worked on a series of job changes that increased my income, and started this blog which—in time—created yet another income stream.
Now, let’s break this down and see how you can apply these three requirements to your debt.
Confront Your Debt
I’ve written before about being afraid of your finances, because I think this actually happens. There was a time in my early twenties, when my debts were steadily mounting, that I knew I was in trouble, but I was too scared to actually tally up how much debt I was in. I paid minimum payments, and forgot about them until the following month. If this is you—or if you simply need a refresher as to your current (negative) net worth. Let’s take a look. Tally up all your debts. Credit cards. Student loans. Auto loans.
And anything else. For now, we’ll leave any mortgages out of it.
For repayment purposes, you can hold off on paying off early and student loans with really good interest rates (say, sub-seven percent). But for benchmark purposes, include those, too.
That’s your number.
Although your absolute total debt is important, it’s not as important as how that debt compares to your annual income. It’s time to calculate…
A debt-to-income ratio is a commonly used figure, but it’s often calculated different ways. For example, when you apply for a mortgage, the banks calculate your DTI as the percentage of monthly debt payments of your MONTHLY income.
Last year, I reviewed the book Your Money Ratios by CBS MoneyWatch columnist Charles Farrell. I liked Farrell’s idea of simplifying financial planning by applying ratios to personal finance (something that financial professionals do all the time, anyway).
Although not one of Farrell’s ratios, I like to calculate a Debt Ratio as the amount of total debt (excluding mortgages) as a percentage of gross annual income.
- Example 1: You earn $50,000 a year and have $25,000 in debt. Your Debt Ratio = 0.5.
- Example 2: You earn $100,000 and have $250,000 in debt. Your Debt Ratio = 2.5.
This gives you a benchmark for how indebted you are (and what it will take to escape). Here’s how this breaks down.
- 0.0 – .19 (Not Bad)
- 0.20 – .34 (Fair)
- 0.35 – 1.0 (Poor)
- 1.0 – 2.0 (Warning)
- 2.0 or more (Oh, hell)
In case you’re wondering, my debt was way above 2.0 for a while.
So whatever your debt ratio, don’t despair. If yours is way up there, it just means you have some work to do. If your debt ratio is in the fair range, don’t brush it off…that only means you should be able to pay it off—on your own—more easily (and quickly).
Change the Behaviors that Got You Into Debt
People get into debt for different reasons. School, job loss, medical bills, or, if you’re like me, STUPIDITY. But why you got into debt doesn’t really matter. What matters is that you don’t let it happen again! (If you can control it. You can’t, obviously, control getting sick, although you can make sure you have health insurance.)
- If you took out $50k in student loans for a bachelor’s degree, don’t take out $100k more for a PhD.
- If you fell into a pile of debt after losing your job, resolve (once you get out of debt), to work on an emergency fund should this happen again.
- If you, like me, spent years living a life you couldn’t afford, then figure out what the life you can afford looks like, and get there.
This last step is easier said than done. In fact, that goal alone is responsible for about a third of every personal finance article every written. “Live within your means,” “spend less than you earn,” etc., etc. Why has so much written about such a simple, simple concept?
Because once we get accustomed to living a certain way, it’s incredibly difficult to change. You know, how do you start living on Ramen after two years of The Capital Grille?
That’s where this comes in:
Earn Enough to Get Out of Debt
Getting out of debt (and doing it on your own), not only requires you to live within your means, but to live below it. Put another way: you need to go from a situation in which you’re spending more than you earn into one where you’re earning more than you spend. And the faster you want to become debt free, the more you have to earn above and beyond what you spend.
Personally, I knew I was never going to get out of debt just by cutting spending unless, perhaps, I lived with my parents until 35. (No offense, Mom and Dad, but no thanks.) I simply didn’t earn enough money. I had to earn more. So I did several things: I got a second job (at Starbucks, of all places), I looked for higher paying day jobs and moved (a couple of times), and I started this blog. Between the second job, a career change, and starting blogging, I added $15,000 to my annual income. And in about four years, I went from earning just over $30,000 to making over six figures.
I do not say this to brag or to claim that I’m anything special. I say it only to make a point. If you put your mind to it, you CAN get out of debt. If you put your mind to it, you CAN increase your income. If you put your mind to it, you CAN get a better job. If you put your mind to it, you CAN start a part-time business.
Not everybody has to earn more money to get out of debt, but it makes it a lot easier.
IDEAS FOR EARNING MORE MONEY
There are literally endless ways to earn extra money, but all could fall into these three categories.
- Sell stuff.
- Work harder.
- Work smarter.
Selling stuff. If you have STUFF, then you can make money. Find stuff you don’t use anymore and hit up eBay or Craiglist or a yard sale. If you want a kick in the pants to do this, buy a copy of Man vs. Debt’s Sell Your Crap course (I’m not an affiliate, I just love Baker’s stuff). The good thing about selling stuff is you can get cash fast. The bad news is it’s not sustainable; sooner or later, you’re going to run out of crap to sell.
Working harder. Get a second job or work overtime, if available. I’ll be blunt, second jobs are no fun. Think of how tired/stressed/soulless you feel after your 9-5 already, now imagine getting in your car, battling rush hour traffic, and putting in another four hours from 9-10. Then you get home around 11, just in time to watch the Daily Show and pass out. Putting in extra hours earns extra dollars, but it can suck the life out of you. If this is the route you want to go, however, there are options: food service, babysitting, mall stores, delivery routes, security guarding, tutoring, teaching prep classes, bartending, cab driving, etc.
Working smarter. This is my personal favorite way to increase your income, and you’ll see why. Working smarter is about getting promoted at work. Or, if your job won’t promote you: finding a higher-paying job. Or, if you can’t find a higher-paying job: working for yourself. If you make the decision to earn more money by working smarter, you just have to DO.
Note: I can’t take the space here to list a million business ideas, but I have always found inspiration in the Inc. 500, a list of the fastest-growing companies in America. (My first college internship was with Inc.—my job was to interview the CEOs of these companies to about the secrets of their success. It was one of the best experiences of my life.) I still think of that list as “500 ways to make money”.
Motivation is half the battle, but if there are tools available to help you get out of debt yourself, why not take them?
For anybody who wants to get out of debt on your own in 2011, there’s some very good news. It’s not 2010 (or 2009, or 2008). The credit crunch is over. That means, unless you totally scorched your credit score, you may be able to use the credit system to your advantage to help you escape it.
The 0% credit card balance transfer if back, and in a big way.
For newbs: As a way of attracting new customers, credit card companies will let you transfer a balance (in other words, transfer debt) from another credit card to their credit card at a low interest rate for a said number of months. Theoretically, if you transfer a $2,000 balance at 15% APR to a 0% for 12 months balance transfer card, you could save up to $300 in interest.
There are, of course, pitfalls to this approach. In fact, there are a lot of them. For example:
- There is often a fee to transfer a balance, eating into savings.
- Transferring a balance doesn’t solve your problem, it just moves it.
- You need good credit to get approved for new credit card. (Probably a score 0f 700 or more. You can check your score to get a sense if you’ll qualify.)
- More credit means more temptation to spend.
Those risks aside, balance transfers can save you money. Current balance transfer credit cards offer 0 percent for up to 18 months. Got a balance at a crazy rate? If you can get this offer and transfer it without a fee, then pay it off in a year, you can save yourself hundreds.
Consider balance transfers carefully, but don’t be afraid to use them if they can help you. In general, look for offers with no fees, 0% APRs, and periods of 12 months or longer. (See current offers here on my recommended credit cards page).
Eventually, I got to a point where a) I had too much debt to get new credit cards and b) balance transfers obviously didn’t work for me because I would transfer the balance and just spend again on the old credit card. Sound familiar? If so, you may find help in peer-to-peer lending.
Peer-to-peer lending networks like Prosper and LendingClub allow individual people to make unsecured loans to other regular people. No bank involved. You’ll still need good credit to get a personal loan, but you may be able to get a lower interest rate than credit cards in the form of a fixed payment loan (for either 3 or 5 years). That way, you can’t be tempted to make minimum payments.
If you think consolidation loan could help, learn more about Prosper or LendingClub. (I’m now an investor with LendingClub and can vouch that both are legit and AWESOME. It’s the future of consumer finance.)
CREDIT COUNSELING AND DEBT MANAGEMENT
Part of taking the steps necessary to get out of debt is admitting when you need help. Although you can save money by getting out of debt on your own, sometimes it just doesn’t work. That’s where credit counseling and/or debt management may be of help. Just PROCEED CAREFULLY. Although the government has cracked down a bit in recent years, there are a lot of companies out there that advertise these kinds of services that will only make matters worse. AVOID debt settlement scams or any service that promises to reduce the total amount you owe. AVOID any service that charges big upfront fees.
The National Foundation for Credit Counseling is a non-profit organization of reputable credit counselors that can direct you to somebody in your area that can help you make a plan to get out of debt. They may charge a fee for their time or on a monthly basis.
You may also want to research (either through your counselor or on your own) entering a debt management plan. Under such a plan, a third-party company negotiates interest rates, payment amounts, and fees with your creditors. You make one monthly payment to the third-party company and they pay all your creditors. Read 10 things to know about debt management companies to help you decide if this is a route you want to go. If you decide it is, I recommend CareOne Debt Relief Services®. (I actually used them towards the end of my road out of debt to reduce my interest rates and help force me NOT to use the credit cards I was working so hard to payoff. Full disclosure: I’m also a compensated affiliate of CareOne.)
YOUR NEXT STEP
Are you still reading this? Amazing. Thank you! The bottom line is, none of all that I’ve just written is worth anything unless YOU take action. And although getting out of debt is a long process, you CAN start today. And that’s what I ask you to do:
Within 24 HOURS, I want you to DO SOMETHING—ANYTHING—towards getting out of debt. If you do, please SHARE it in a comment.
Here are just a few ideas of things you could do, but I urge you to get creative!
- Cut up a credit card.
- Post something you own for sale.
- Write down a goal to earn more money.
- Submit an application to a new (higher paying or additional) job.
- Transfer a high-interest rate balance.
- Confront your debt (write down your total debt and debt ratio).
- Reexamine your budget.
- Make an extra debt payment.
- Look into credit counseling.
How are you going to get started?