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Whether you’re just starting out on your own, or you’ve decided that it’s time to take control of your financial situation, one of the major things you need to do is manage your household debt. Here are the basic steps you’ll want to take:
1. Make a list of your debts.
I’ll admit, this is no fun. But to get to where you want to go, you first need to determine where you are. So, list your mortgage, car loans, student loans, credit card debt, and any other money you owe to someone else.
2. Decide how you want to handle your debt.
My hope is that you’ll want to pay off your debts quickly, because I know from personal experience how great it feels. But you may decide that you’re content to pay the minimum and carry the debt, at least for now. You have to decide what’s right for you, and no one else can tell you what that is.
3. Prioritize your debts.
Assuming you want to pay off your debts, the next thing you should do is decide the order in which you’ll attack each debt. You could attack them all equally at the same time, but it’s easier, more rewarding, and often cheaper, to pay off one debt at a time.
The fastest and cheapest way to pay off your debts is by attacking the one with the highest interest rate first. You’ll pay the minimum on all of your other loans, and put all of your other debt payoff funds toward the debt with highest interest. Once that’s paid off, you focus on paying off the loan with the second-highest interest rate while continuing to pay the minimum on the rest of your debts. And you repeat this pattern until your loans are all paid off. This is what’s frequently referred to as the Debt Snowball, because you’re “snowballing” your money from one debt to the next.
If your highest interest rate loan is large, and you have a lower interest rate loan that’s comparatively small, you may find it more psychologically rewarding to pay off the smaller loan first. You might pay a little more in interest in the long run, but the psychological benefit of eliminating smaller debts and the mental clutter they create should not be overlooked.
And speaking of psychological benefits, if you have a personal loan from a friend or family member, it may be best to pay that one off first, even if it’s your lowest interest loan, because of the impact the debt may have on your relationship.
4. Choose a method.
I’ve already mentioned the debt snowball, and I’m proof that the debt snowball method works. But it’s most effective when you’re willing to commit to living well beneath your means so you can apply as much money as possible to the snowball. You should take a good look at your expenses and spending habits, and decide on how much of each paycheck can and will be used to pay off debt. I also recommend setting up a system for making that payment as automatic as possible, so you’re not tempted to spend the money in other ways.
After you’ve got your snowball set up, consider the the Debt Snowflake, through which you direct any small amount of money you can toward paying off your debt. The idea is that every quarter you pick up from the ground, every monetary birthday gift, and all other small amounts can add up to chip away a big chunk of debt. In fact, once you’re on a roll, you’ll probably be motivated to find as many snowflakes as possible, by selling items (I used Amazon), earning extra money (I love Swagbucks), and more.
5. Get accustomed to a new lifestyle.
As you pay off your debts, think about making the mental adjustment to living without owing anyone money. For example, I was so accustomed to thinking that you get a loan when you buy a new car that I still remember my shock when I realized we didn’t have to get a loan. And so we’ve been saving so that we can pay cash for our next car. I’m still working on paying off the mortgage, but I am confident that we will get there, and in less than 30 years.
Your new way of thinking will ensure that you don’t take on any additional debt. Be sure to allocate some of your income for an emergency fund, even if it means your debt snowball is a little smaller than it could be.
Once you’ve discovered how amazing it feels to have your finances under control, you’ll have your debts paid off in no time!