Greetings, Wise Dollar friends! If you’ve been following along with our monthly series on how to get out of debt, you’ll know that we started with a post on the importance of having the right attitude regarding your journey to debt free.?We followed that up last month with a post on?assessing your financial situation.?At this point, you should have a good idea about what your debt and asset situation is, and a clear understand of what kind of mindset you’ll need in order to make your journey to being debt free successful.
Today, we’re going to talk about the importance of formulating a plan for getting out of debt. Yep, here’s where the fun work begins. No sarcasm here; getting out of debt truly can be fun. Once you formulate your plan and start seeing those debt numbers go down, you will indeed be having more fun than a day at a Disney theme park could ever bring you. 🙂
Get Out of Debt – Your Plan, Your Way
One quick Internet search and it becomes crystal clear: there are many, many ways to pay off debt. This is why customization of your get out of debt plan is so vitally important. Only you know what makes you motivated to keep striving for a goal and what causes you to want to give up.
For instance, two popular methods of debt repayment are the Debt Snowball and the Debt Avalanche. The Debt Snowball works by paying off your debts in order from smallest to largest. Financially, the snowball is not usually the best way to go, but emotionally, seeing those debts crossed off the “I owe” list faster brings huge emotional wins, which often encourages a person to keep on that journey to debt freedom.
The Debt Avalanche requires that you pay off the highest interest loans first. On paper, you’ll still see the same list of debts you’ve always seen, but the numbers will be getting smaller. From a purely mathematical standpoint, getting rid of the highest interest loans first will allow you to become debt free quicker – provided you can avoid discouragement from not seeing those debts crossed off quicker like you do with the snowball method.
The take-away here is that you need to discover a plan that will allow you to be the most successful in your debt payoff journey, and customize it to your specific income, payment and debt situation. Once you discover that plan, feel free to modify it when necessary based on changes in your financial situation as well. Regularly assessing what works and what doesn’t is key to taking your debt payoff plan through to the finish line.
Your “Get Out of Debt” Budget
Spend tracking and budgeting are crucial to your debt payoff plan. Those two steps will help you to find all extra money possible to put toward debt repayment. So, the first thing you need to do in this process is to commit to tracking all spending.? This will help you to discover any financial leaks that might be punching a hole in your plan to become debt free. Second, you need to make a……budget.
Don’t panic: although budgets often conjure up images of balls and chains, I’m here to change your views on budgeting. You see, what budgeting, and spend tracking, truly offer you is FREEDOM.
How?
By giving you a crystal clear picture of your spending habits, and allowing you to then make future spending decisions based on what means the most to you. With budgeting and spend tracking, you can see that you’ve been spending a lot more than you thought at happy hour, and you can take that $500 a month you’ve been spending on happy hour and put it towards that home you’d like to purchase. Or that trip to Australia. Or that early retirement fund.
Budgeting and spend tracking, as a part of a complete debt payoff plan, allows you to manage your money in a way that ensures you are spending it on the things that mean the most to you.
So, when you make your budget, the plan is to make a line item for every bill you owe each month, for any savings funds, and then put extra toward debt. This is called a zero-sum budget. A zero-sum budget ensure each dollar that comes into your account has a place and a purpose, like this:
Joe’s Monthly Income: $3,000
Mortgage pmt:??????????????? $1,000
Gasoline:????????????????????????? $100
Groceries:??????????????????????? $200
Entertainment:????????????? $200
Clothing:???????????????????????? $50
Utilities:????????????????????????? $125
Insurance:???????????????????? $75
Gifts:?????????????????????????????? $35
Pet Costs:????????????????????? $30
Home repairs:??????????? $40
Visa minimum:????????? $210
Mastercard min.:????? $175
Student loan min.:??? $85
401K:?????????????????????????? $150
Emergency fund:??????? $50
Total needed each month:? $2,525
Okay, so our fictitious consumer, Joe, has an income of $3,000 a month and monthly expenses totaling $2,525 a month.? This leaves an extra $475 floating around in Joe’s budget. In a zero-sum budget world, Joe would take every dime of this $475 and put it toward his debt in the manner he’s deemed most efficient for his personal and emotional needs. That extra $475 a month will allow Joe to put an extra $5,700 a year toward his debt, not including the massive amounts of interest he’ll save in the process.
By having a plan,?a personalized plan,?Joe will be able to knock out his debt much, much quicker than he would have by simply making the minimum payments. And this fast track to debt free was all made possible by a simple budgeting and spend tracking plan that was customized to fit Joe’s specific personality and situation.
Do you have a budget and spend tracking system in place for your money? If so, how has it worked for you? When you’ve paid off debt, do you attack the lowest balance or highest interest rate first?
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I love budgeting =) We use a zero-sum budget which basically requires us to “spend” all of our money on paper before the month starts. I really like how well it works for us!
I’m a big fan of the zero-sum budget – you literally cannot mess it up! 🙂
Loving this post right now! 🙂 I just redid my budget to make it more personalized and make it so that I really stick to (more readable and useable). My boyfriend also just did a budget for the first time, and it is geared toward him getting out of debt, using the zero-sum budget.
Go, zero-sum budget! Woohoo! 😉
I also do a zero based budget and I spend all my money on paper at the beginning of the month. I pay myself first at the beginning of the month and if I have any extra money at the end of the month I also add it towards my savings. I keep track of every day expenses on my phone with an envelope system app which subtracts what I allowed myself to spend for that month.
That’s three for three on the zero sum budget. 🙂 We don’t own smartphones, but I hear those apps are awesome!
I think the key word with budgeting and debt repayment is personalization. I know from myself and my clients that no one solution is the best one. I do know that it is important to have something in place. I was one of those people who hated the word budget (just like I hated diet). But that was because I am not good with the monthly strict numbers and sticking to them. I am great at setting goals and making them happen, though, so I have moved to a goals based budget system and I save more and spend less than I ever have. You can’t just say you are not good at something and then just not do it. You need to find the best solution for you and work it.
“No one solution is the best one”. So true, Shannon! I like the idea of the goals based budget system. Rewards often work so much better than strict guidelines, don’t they?
I used the debt snowball along with listing my debts based on the highest rates of interest when I was paying off debt. I use a budget that I review every month and include non-monthly expenses. I have a target number for each category and work to reduce spending in categories that are way above the targeted amount if it occurs too frequently.
I like the target number idea, Kassandra. That sounds like a smart idea. Thanks for sharing!
We paid off some of the smaller debts first, regardless of interest rates. Getting them off the balance sheet is a good morale booster. It’s easy to get overwhelmed and give up if you don’t have a few victories in the beginning.
I know that really works for a lot of people, Kim. This is what I love about personalization: it gives one the ability to customize their plan to their own individual situations.
Great article. I agree with Aldo in paying yourself first. Dang it you worked hard for that money so you should be first in line for payment. We take the debt payoff approach and flip it around for our investments in our budget each month. The highest earning investment gets the most money to “pay off” ourselves. Then some gets put in to savings for just in case money which earns a lower percentage. Then we pay the bills and any leftover is applied to savings again.
Without a budget or a plan, you are just guessing and hoping things work out and that almost never works especially in the long term if you are trying to accomplish your financial goals
“you worked so hard for that money so you should be first in line for payment.” Lance, LOVE that. I’ve never thought about it that way before!!! Love how you’ve flipped the debt payoff approach and applied it to your investments. Smart move!
I wrote about this in one of my recent articles on the debt snowball vs. the debt avalanche. I personally used the snowball method to become debt-free, but if I had to do it again, I would have used the avalanche. I am a huge fan of budgets too, which I still use to meet my investment goals. Overall, if you need the emotional support of small wins, do the snowball. Otherwise, do the avalanche. Great article!
I totally agree, Kalen. We started with the snowball, because of the emotions factor, but that quickly was overtaken by annoyance at the amount of interest we were paying, and that allowed us to have the emotional stability to switch to the avalanche. It feels so good to be paying off more interest!
I love zero based budgets. Having a plan in place each month helps to guide your decision making process.
We are using a debt snowball listing debts smallest to largest. Paying off some of the smaller debts allowed us to really get the snowball rolling and make incredible progress. When looking at two debts of similar size, we would choose the higher interest debt. To date, we’ve paid off over $115,000 in debt using this method. It might cost a bit more in interest but the more frequent wins you achieve by paying off the smaller balances help keep you motivated.
Kristin, that’s awesome!! You guys are doing terrific! It’s so important to do the plan that best works for your individual personality and situation. Without that, failure rates skyrocket. I’m with you on the zero-based budgets too – they’re my favorite. 🙂
I like to look at a budget as freedom as well. Don’t look at it as a negative thing, restricting your spending, look at it as a tool to allow you to work the job you want to work, and have the life you dream of. If you set up a good budget and follow it, it will do just that for you – allow you to live a better, happier life. Look at the positive, not the negative of a budget!!