Wednesday, 30 January 2008

How to get out of debt

Eliminating debt from your life can be the same as doubling your income! Being free from debt is guaranteed to turn your life around and reduce the level of stress that you and your family have to face.

Credit is both useful and dangerous. Freely available credit allows us to buy today what we can't afford today. But easy access to credit often leads to large amounts of debt. With large amounts of debt people discover that they are in trouble. Their income no longer covers the expenses and there seems to be no end in sight.

Many articles about getting out of debt suggest a debt consolidation loan. This may help in the sort term, but remember: debt consolidation does not get rid of the debt problem! It combines all your debt into one. It turns short term debt into long term debt. It may ease the budget, but the benefits are purely temporary.

If you are in real trouble where your debt exceeds your assets, then sequestration or bankruptcy may be the answer. You will be starting again with severe restrictions on your financial independence. Once rehabilitated, you will own nothing but be debt free! Do this if you have to, but only when you have tried everything else.

For most people, the solution lies in setting up a debt elimination plan. The plan is simple to follow but will require some difficult short-term lifestyle sacrifices. However, the debt elimination plan will ensure that you will be living debt free relatively soon!


Identify how much you owe and what you spend each month to repay debt.

Make a list of every debt repayment that you have. Include the mortgage, car finance, personal loans, credit cards, store cards, companies and people that you owe. Include payments that are in arrears. If the rent is in arrears, then it too becomes a debt.
For each debt, List the current repayment, the rate of interest charged, the outstanding term, payments that are in arrears.

Get the total monthly repayments and the total amount owing.

Knowledge is power! Knowing the extent of the problem is the first step towards fixing it.


Now review the total household budget.

If you don't know where your money is going then carry a notepad with you for the next month. Write down every payment that you make. The more detail you record, the better.

Make a list of everything that you spend and pay on a monthly basis. Include all repayments.

Total your monthly expenditure items to get a grand total.
List your total household income in a separate column. Compare the total of this to your total expenditure.


Involve the entire household in reviewing the budget. Review each item. Ignore fixed costs for now. Identify any spending that you could easily do without.

Look for luxuries or spending that can be cut. Use the detailed list that you created over the past month. Keep reviewing the budget to see if there are any areas where spending can be reduced.

If you cannot reduce your spending plan this way, then look at your debt and investment portfolio.

It may be prudent to suspend monthly investments for now. Once you are debt free, there will be much more available for investment. Don't stop life insurance premiums or retirement contributions unless this can be done without penalties.

Finally, look at your debts. Make arrangements with the bank to pay interest only on your mortgage (and perhaps on other longer term debt) for the next few months. Try to negotiate a lower rate of interest on your credit card, home-loan and overdraft.


We will call your new budget a spending plan. There should now be a surplus of income over expenditure. If there is no surplus, then go through the previous steps again. Perhaps look at ways to earn extra income.


The action plan involves targeting your debts one at a time. Go back to your list of debts. The usual advice is to target the debt with the highest rate of interest. It is more effective to target the smallest debt first. The reason for this is to free-up funds as quickly as possible to pay off more debt more quickly.

Take the debt with the shortest remaining term. Add the surplus that you created in Step 4 to the normal repayment. Pay the additional amount each month until the debt is paid.

The total enhanced repayment of the first debt has been freed. Once again select the debt with the shortest remaining term. Add the freed-up funds from the paid-up debt to the normal repayment. You will be able to pay off this debt much more quickly!

Each time a debt is repaid, more funds become available. Repeat the process until you should have repaid everything but the car and home-loan.

During this phase of the plan, all available funds are used to eliminate debt. Each time a debt is paid up, more funds are available to pay off the next debt. You are becoming one step closer to living a debt-free life!


The same principle may be applied to the car finance, but check that you will save by repaying early. If you will be charged the full-term interest there is little point in repaying it now.

If you apply all of the freed-up funds to your home-loan, you could reduce the repayment term by 50% to 75%. Pay off your home in five years rather than twenty, and save a fortune on interest.

You will be living in a paid-up house with a paid-up car and no debt. You should have enough cash flow to buy major items with cash.
However, you may decide that it is time for a reward. Increase your mortgage repayments, but allow some extra for yourselves.


Having achieved this step, it is important to maintain the new status quo. With the exception of a home purchase and perhaps a car, pay for everything with cash. Buy it when you can afford it. Spend only what you can pay for.

Set aside ten to fifteen percent of your disposable income for investments.

You have taken the first step to achieving financial independence. The journey may involve some sacrifices but the rewards are huge.


If followed to the letter, debt can be eliminated relatively quickly achieving massive long-term savings on interest.

Be flexible if you must it is your choice. Reward yourself each time a debt becomes paid-up. Add a portion of the freed-up cash to improve your living standard. It will take a little longer, but perhaps you need to feel the rewards as they occur.

1 comment:

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