Dear Five Cent Nickel Readers,
Thank you for stopping by Wealth...Uncomplicated where from time to time, I post articles designed to help you move forward with your finances. Since the post that brought you here was about how to get out of debt, the following is a bigger picture view that applies the financial planning process to the elimination of debt. It is through this process that results are achieved, for personal finance has, is, and always will be a journey rather than a destination.
Also, feel free to bump around the site and if you like what you see, I'd be honored to have you as a subscriber. Either way, thanks again for visiting Wealth...Uncomplicated.
Debt and financial planning are rarely used in the same sentence - particularly in the professional community - because there simply isn't any money in it. This is an unfortunate truth, but for those of you in debt up to your eyeballs, the financial planning process is exactly what you need to extricate yourself from the burdens of debt.
What is the Financial Planning Process?
As with any process, there is a series of steps that put together lead to results. The base financial planning process is just six steps:
- Gather Data
- Set Goals
- Analyze Current Condition
- Develop Possible Courses of Action
- Implement Plan of Action
- Monitor Progress
While this is a pretty standard setup, let's take a look at how this applies to getting out of debt.
Gather Data
When it comes to debt, the data part is pretty simple. You need to know your after-tax income and a complete run-down of your debts. To do this, here's a simple spreadsheet to host your debt listing:
Download Budget and Debt Worksheets - Open Office
Download Budget and Debt Worksheets - Excel
Set Goals
Obviously the goal with getting out of debt is to get to zero. However, it's a little more complicated than that as not all debts are created equal. There's everything from the uber-expensive payday loan to low-interest rate, tax deductible mortgage loans. For this reason, it's best to set a series of goals rather than a single goal of 'Get to Zero by X Date'.
An important reason to set interim goals is that you need to feel like you're making progress. If you simply say, "I want to be debt free," you risk thinking negatively about your progress. In other words, a series of smaller wins is what leads to the big win in the end.
A common way to break down your debt goals is to do it by category - e.g. payoff all store credit cards, payoff all major credit cards, payoff all student loans, etc. Some also group debt into 'good' and 'bad' debt types. 'Good' debt usually includes low interest rate loans that also carry favorable tax treatment like mortgages and student loans. 'Bad' debt includes just about everything else.
Regardless of what your goals are, set checkpoints along the way that will help boost your confidence and move you forward towards a debt free life.
Analyze Current Condition
In this step, you need to examine your current financial condition. Moreover, you should also figure out what the underlying issues are that put you in debt. Let's begin with some conditions that need to be addressed prior to pursuing a debt elimination plan.
Do you have an income problem or a debt problem? This is critical because income is the engine with which debt elimination is made possible. If you find that after stripping away all but the most basic monthly expenses, you still cannot meet your minimum payments, you have an income problem that must be addressed prior to attempting to payoff your debts.
Do you have a systemic expense problem? Sometimes you'll find that even after cutting discretionary expenses to the bone, there still isn't enough money left to feed your creditors. If you're making decent money, then you likely have a systemic expense problem rather than an income or debt problem. Systemic expenses are those that you pay each month that don't go away. The two largest are housing and transportation which impact more than ten different line items in your budget. If you're committed to too much house or too much transportation, think very hard about downsizing one or both. It makes getting out of debt a much easier proposition.
If neither of the two above apply, how did you get into debt? Whether it be overspending, medical bills, inadequate insurance, a death in the family, or some other issue, you need to include in your analysis a history of how you came to this point. Whatever the issue, be sure to start thinking about ways to avoid recreating the circumstances that led you to your current position.
Develop Possible Courses of Action
Now that you have your data, goals, and current analysis, the next step is to develop some possible courses of action that will lead you to your goals. With this step, there are generally three basic plans of action that you should explore. The one you choose should be dictated by your personality and not the mathematics.
The most intuitive approach is to payoff the highest interest rate debt first and then work down the list from there. This type of plan will always yield the best results if you follow through with the plan. Of course, that's a big if. This plan is best suited for those with a great deal of self discipline and an analytical/mathematical mind.
The next approach is to payoff your debts from smallest to largest and is the same way that Dave Ramsey advocates. The main reason for using this approach is that by paying off smaller debts first, confidence is boosted along the way - meaning you're more likely to continue paying balances down. Aside from this, there is a mathematical benefit as well in that if you have a large number of debts to repay, knocking off the smaller debts reduces the number of payments and thereby the number of potential late and over the credit limit fees.
Finally, another way of going about getting to zero is to payoff your debts based on the payment-to-balance ratio. This method has been popularized by John Commuta, creator of the Transforming Debt into Wealth System. The gist of this system is to payoff the highest payment-to-balance ratio debt first and move down the list from there. Your total of payments never comes down until you are completely debt free which for most will be between four and seven years. It also relies on a kind of 'initial' push to get going, but once in full motion, it's a very powerful way to eliminate debt. This approach will have appeal to systems-oriented and impetuous personality types. Systems folks will love the ratios that lead to ever accelerating debt reduction. Impetuous types will enjoy the fact that they're using a system that's somewhat 'outside the box' and different from the traditional mantras.
Regardless of the plan of action you like best, list your debts in the order in which you'll pay them off. Before paying off any debt, it's a good idea to set aside $1,000 to $1,500 in cash to cover the minor emergencies in life and to sell some 'stuff' to help you get a fast start. At this point, you should have your debts listed in order and have a pretty good idea of how you're going to pay them off.
Implement Plan of Action
With your plan in hand, it's time to go about the hard work of implementing your selected course of action. This is the most challenging part of the exercise, as making the 'rubber hit the road' is always more difficult that creating a plan. During this phase (which can last months, years, or even decades), remember to focus on your goals and concentrate your efforts only on what is in front of you. In other words, don't get distracted, keep your eyes focused on the task at hand.
So what are the steps to get out of debt? According to your plan, you know what needs to be paid off at any given time, and all you need to do is find as much money as you can each month to reduce that balance. If that means that from time to time you need to pick up an extra job, get another job. If it means you need to cut back or eliminate certain expenses to get the job done, do it. The bottom line here is that you need to do whatever it takes to keep moving forward.
Invariably, situations will arise that will knock you off track. When these things come up, don't think about your debt, but tackle the issue at hand. Sometimes this will be an unexpected expense or a temporary lapse in judgment. No matter the issue, handle it first and then re-focus on your debt elimination plan.
While this post won't allow for the exploration of all of the ways to implement your plan or how to deal with setbacks, there are three habits that you will find of great use:
- Write and Recite - when you wake up, at each meal, and before you go to sleep each night, read aloud your #1 most important goal - e.g. I will payoff my American Express card
- Dave Ramsey Daily - love him or hate him, this guy knows debt and listening to his free podcasts daily will help you keep your focus while delivering some ideas on how to accelerate your debt elimination plan
- Find Your Voice - unlike previous generations, talking about your situation with friends and family isn't a taboo thing; by speaking about your debt plan and progress, you can create a greater level of accountability to help you stay on target
These are the three best habits that I can recommend to you and you'll see that they are all based on the stuff between your ears. There is a very good reason for this - your success or failure rests entirely in your brain. If your mind is constantly working over how to move forward through the 'Write and Recite' habit, you'll find ways to achieve your goals. With 'Dave Ramsey Daily', you'll enjoy a like minded audience and learn more about debt and people than you can imagine. Finally, by 'Finding Your Voice', you will be able to materialize your goals among your peers that will no doubt help you in staying the course - not to mention helping others improve their finances along the way.
While implementing your plan, if you can develop the right habits and fundamentally change the way you think and interact with debt, you'll be miles ahead of where you are today. The three habits listed above will go a long way towards changing your mind which will, in turn, change your behaviors for the better.
Monitor Progress
As with any plan, you need to take a few minutes from time to time to monitor your progress. If you're using a spreadsheet to track your progress, be sure to record the balances owed when you begin working your plan. This will establish a baseline to help you determine how much progress you've made. When you get a chance to listen to Dave Ramsey on a Debt Free Friday, you'll here stories of people that have paid off insane amounts of debt in relatively short periods of time. It is a major motivator to see that your hard work is paying dividends, so be sure to look not just at what you've done in the last week or month, but what you've accomplished since you began.
What if things are going badly? Ouch! If things are trending the wrong way, there must be bigger or newer problems from when you crafted your plan. When this happens, go back to the beginning and start over. Identify the reasons things are going the wrong way and fix that first. The fact of the matter is that debt is a symptom and not the disease. Until you root out the disease and treat that first, debt will continue to pile up.
Closing Thoughts
Eliminating debt is a pain in the backside to be sure, but becoming debt free is a deeply fulfilling accomplishment. Talk to anyone that's paid off a lot of debt, and you'll find that no matter the pains involved in pursuing a debt free lifestyle, it's always worth it in the end. When was the last time you heard someone say, "I wish I had more debt!" Umm, I'm guessing...
never.
As a final note, if you are in debt and would like to use a new technology to help you through the financial planning process, my company will begin an initial test of the debt elimination portion of TodayForward on April 26th. We are inviting a limited number of folks to test the solution in advance of our public release. To sign up to become a test user, click here to join the waitlist. Testers are asked to provide suggestions and criticisms to help us improve the solution and may use the application for free through the testing cycle.
Recent Comments