If there is one thing that will hold you back from reaching financial freedom, it’s debt.
Many of us are never really taught how to manage money properly. It certainly wasn’t taught at my school. You may even have parents that didn’t have great money habits. As a result, many people find themselves getting into trouble with debt. The problem is that debt can grow rapidly because of compound interest. If you don’t manage it properly it can easily spiral out of control.
So, if you want to take back control of your finances, here is my step-by-step guide to getting out of debt, once and for all.
Step1: Self Awareness
The first and most important step in getting out of debt (and staying out) is to understand what got you into this position in the first place. What circumstances, thoughts, feelings and behaviours led you to spend in this way? This step is not easy. It requires real self-reflection and honesty, which can be difficult to face. But if you’re going to permanently change your financial situation then you also need to change your beliefs and your behaviour.
Were you impulse buying? Spending to project a certain image? Spending to numb or avoid a negative emotion? This blog post on changing a spending habit might help you.
Top Tip: review your bank statements with a journal beside you. That way you can write down all the thoughts and emotions that come up when you see where you’ve spent your money.
Step 2: Take responsibility
Once you have a little more insight into yourself and your behaviour, you need to ask yourself a tough question: Are you ready to change?
Taking responsibility is about accepting things as they currently are and understanding that you and only you can change your situation. That doesn’t mean that you have to do it alone, but you have to decide it is important enough to put in the hard work.
Make sure that you don’t take this opportunity to emotionally beat yourself up or punish yourself for past behaviour. Despite what you think, that isn’t a very useful way to elicit behaviour change or create motivation. Forgive yourself, learn the lessons you need and then move forward.
Step 3: Know your numbers
From a more practical point of view, you will need to work out exactly what you owe and to whom. To do this you may have to call and speak to some of the creditors – is the debt still with the original company – sometimes debt can be passed on to lawyers or sold to debt collection companies? How much is outstanding? Is there a minimum repayment amount? What is the interest rate you are being charged?
For some of you, it may just be one or two credit cards, for others it could multiple credit cards, payday loan companies, lawyers, debt collectors, the tax department. Don’t judge yourself during this process, just write it all down. Here is a handy printable I made for you, to collate all of the data.
Step 4: Create a budget
Now that you know what you owe, it’s time to work out how you are going to repay the debt. In order to pay off debt you need surplus cash flow. This is just a fancy way of saying you have money left over after you’ve paid your regular expenses. You may need to make some tough decisions about what you’re currently spending money on. The more surplus, the more you can allocate to repayments. Maximising your debt repayments will help you pay it off faster and save you on interest in the long term. If you need some ideas for ways to save, read this.
Once you have worked out your available cash flow and how much you can allocate to your debt repayments, you need a strategy for doing so.
Step 5: Devise a (realistic) repayment strategy
At this stage, you might be wondering which debt to pay off first. Or whether you should consider debt consolidation. Or whether you should consider declaring bankruptcy in order to have your debts written off.
There are some circumstances where declaring bankruptcy is necessary, but doing so is NOT a get-out-of-jail-free card, it can have very serious implications for your future. If you are considering this, it is important that you seek advice from a lawyer.
For the majority of people, a good repayment strategy and the right mindset is the best way to pull yourself out of the hole of debt.
Once you have a schedule of all your outstanding debts and you know the balances and interest rates, it’s time to prioritise repayment of them. In most cases, you will still have minimum repayment amounts to make each month or fortnight, make sure you factor this into your budget so that you don’t incur fees or mistakenly allocate money you don’t really have.
There are two widely popular methods for repaying debt, the Snowball Method and the Avalanche Method. The Avalanche method is based on paying off the highest interest rate balance and then once paid off, moving to the next highest. The Snowball Method does not consider the interest rate and instead prioritises repaying the smallest balance first in order to reduce the number of loans outstanding.
Personally, I don’t think either method is better or worse. When I am working individually with clients, I often recommend a combination of both. It all depends on your situation and your personality. Paying off large loans can be a slog. I can see the psychological appeal of getting some wins on the board by repaying the smallest balances first. But from a numbers standpoint, if you have a loan with very high interest (no matter the balance) it makes more sense financially to pay it off first. It will save you on both interest and time.
Review your repayment schedule and use your judgement to decide the order in which you will repay your outstanding loans. Based on the regular repayment amount you can then estimate the date you can expect to repay each loan. i.e balance divided by repayment amount = number of periods to repay.
Step 6: Manage your mindset
If you’re familiar with my work you will know that I believe the mindset component to be equally important as the practical, strategic side. Changing habits and beliefs can be tough, so make sure you head into this process with compassion, curiosity and a beginner’s mind. Knowing your ‘Why’, and understanding your drivers and triggers are all important aspects of working towards not only debt repayment but true financial freedom.