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Six Numbers You Need to Know to Actually Get Out of Debt
Just like there are many ways to get into debt, there’s more than one way to dig yourself out. Where some people focus on the debt snowball or debt avalanche methods, others might transfer high-interest balances to a 0% credit card, sell possessions to raise cash they can use to pay down debt, take on a part-time job to speed up the process — or some combination of all these methods.
Any of these strategies can work wonders for your finances if you’re serious about becoming debt-free and prepared to follow through with your plan. And of course, the sooner you get started, the faster you’ll finish and the better off you’ll be in the end. The longer you let your credit card balances and loans languish at high interest rates, the more money you’ll waste along the way.
But, where to begin? While getting out of debt requires a change of mindset more than anything else, there are a handful of numbers you should absolutely know before you begin any journey out of debt – and no matter which plan of attack you choose.
As with anything else, knowledge is power. And when you know your situation inside and out, it’s easier to create a realistic plan that might actually work. If you’re ready to get out of debt, it helps to know exactly “where you’re at.” The best way to find out is to sit down with a pen and paper and write down these incredibly important figures and stats:
Figure #1: The Total Amount of Money You Owe
Some aspects of getting out of debt are particularly painful, and confronting the total amount you owe can be one of the worst moments you’ll experience.
When you owe money across several credit cards and loans, it’s easy to focus on monthly payments and individual balances only. Unfortunately, focusing on each debt without adding them all up can keep you from seeing how dire your situation really is.
To get out of debt, you need to face this number head on. Start by grabbing your bills, a pen, and a piece of paper, and tallying up the total of each balance you’re carrying. While this will look different for everyone, the total amount of debt you need to keep track of includes any outstanding loans or balances you or your spouse are responsible for. This will include credit card balances, car loans, student loans, mortgages, loans in collections, personal loans, and private loans made by friends. List these debts on the left side of one page so that we can add more information as we go along.
Figure #2: Interest Rates for Each Balance You Carry
Now that you know the total amount of debt you owe, you’re in the best position to figure out which debts should be wiped out right away. The best way to do this is to prioritize all of your debts based on their interest rate. If you don’t know the annual percentage rate, or APR, you’re paying on each loan or credit card, you will need to look on your monthly statement, check your online account management page, or call your loan provider to inquire.
If some of your balances are carrying an especially high interest rate (anything over 10% APR), you’ll likely want to prioritize paying those debts off first. The math behind this strategy, commonly called the “debt avalanche method,” is pretty cut and dry: These balances are costing you the most each month. By throwing your extra cash at balances with the highest interest rate first, you can lessen the amount of interest you pay each month. Plus, you’ll create a situation where more of your repayment dollars go directly toward the principal balance of your loans.
Some people choose to take a different approach, however. Instead of paying off high interest balances first, they start by attacking loans and credit cards with the smallest balances instead. Commonly called the “debt snowball,” this strategy can help you win the crucial psychological battle of overcoming debt: Paying off the smallest balances first means you’ll score some “big wins” and start gaining momentum right away in what can be a long, discouraging process.
No matter which debt payoff strategy you use, it still helps to list each debt’s interest rate next to the balance on the page you already created. Once you know the interest rates on your loans, you can decide which debt repayment method is best for you – and which balances deserve your attention first.
Figure #3: The Minimum Payment On Each of Your Loans
No matter how you plan to tackle your debts, you need to know the minimum payments required for each and every one. If you’ve been paying your bills and debts haphazardly until now, you may not know exactly how much – or how little – progress you’re making toward debt repayment each month.
On your list of debts with their respective interest rates, create a third column where you can list each debt’s minimum payment. Once you’ve listed each minimum payment, add them up to find out the minimum payment you need to make across all of your debts each and every month.
Figure #4: The Sum Total of Your Bare Bones Budget
To dig your way out of debt, you need to put a halt to the behaviors that got you there. For most people, that means going on a spending diet, cutting the “extras” out of their monthly budget, and figuring out how to create a lifestyle they can actually afford. At the very least, it’s time to stop adding to your debt.
One place to start is with your “bare bones” budget – a budget that includes only the minimum amount of expenses and bills you need to get by each month. Generally speaking, this strategy requires you to live without all the extras – to get by without much entertainment spending, your monthly cable bill, or your bi-weekly trips to the salon. By living within a bare bones budget, even temporarily, you can free up extra cash to throw toward your debts.
Using a bare bones budget may not sound fun, but it doesn’t have to be forever, either. Once you’re out of debt and have a clearer picture of what you can actually afford, you can begin adding some of the “extras” back into your life.
If you don’t think you need to cut your spending and adopt a bare bones budget, think again. Remember that your current spending habits are what got you into debt in the first place. To change your financial situation, you need to change yourself, first.
Figure #5: Your Monthly Take-Home Pay
Getting out of debt isn’t rocket science, but it does require an in-depth knowledge of your own finances. Part of the equation is figuring out exactly how much money your family brings home each month. While this sounds crazy to the financially minded, many families with more than one earner and multiple paychecks may not even know their exact earnings until they file their taxes each year.
You may know your annual salary, but to get out of debt, you need to start thinking of your income in a “monthly” context. Your bills all arrive monthly, right? You also need to be working with your actual take-home pay, not your gross salary. If you want to use your own monthly income to get out of debt, you need to know how much of it you have in your bank account to work with each month.
One way to do this is to simply sit down and add up your household paychecks during a single month. Alternatively, take your weekly take-home pay (after taxes, health care, 401(k) contributions, etc.), multiply it by 52 weeks, and divide the total by 12.
Once you know your true monthly income, you’ll have a greater understanding of what you can actually afford – and how much money you have available to pay off debt.
Figure #6: Your Discretionary Income
At this point, you should have an understanding of your total debt load, the interest rates you’re paying, your minimum monthly expenses, and your monthly income. When you compare all of those numbers together, it should become apparent how much money you could be throwing at your debts every month.
When you live on a bare bones budget, the amount of money you aren’t spending each month should grow tremendously. This “extra cash” is called your “discretionary income,” and this is where the rubber hits the road.
By throwing those extra funds toward your smallest balances or the loans with the highest interest rate, you can start really digging your way out of debt once and for all.
However, this strategy only works if you use those funds to pay down debt instead of wasting them somewhere else. To get out of debt and stay out of debt, you must truly be mindful when it comes to every dollar you make – and every dollar you spend.
The Bottom Line
If the idea of getting out of debt has you feeling overwhelmed, remember that it’s just simple math. Income – expenses = savings, right? To create a scenario where you have extra money to use towards debt repayment, you have to either a) boost your income, or b) cut your expenses. While debt might make your life overly complicated, the math behind getting out is actually rather simple.
Still, it’s almost impossible to get out of debt when you’re unaware of your total debt load, how much interest you’re paying each month, and the bare minimum amount of money you need to get by. To get out of debt, you have to face these cold, hard truths.
Getting out of debt is hard work, but it isn’t impossible. More than anything else, you’ll to face the one true enemy who keeps holding you back – you.
How did you get out of debt? Was it easier knowing all of these numbers first?