Three Step Approach to Clear Your Debt

Debt is very much like quicksand – easy to stumble into and once you are in it, very difficult to get out again.  In fact the more you struggle, the more you start to sink.

Debt QuicksandFear not, because help is at hand and with a three step approach to clearing debt, that will soon have you enjoying a debt-free lifestyle again.

Step One – Understand Your Current Situation

Before you begin to solve a problem, you need to fully analyse and understand it.  Imagine you have set off on a weekend away in the country.  However on the way to your hotel you end up getting lost.  You have a map, but before you can re-plan your route you need to find out where you are.

The same principle applies with your debts.  It is very difficult to plan how you are going to get out of debt, until you understand these key points:

  • How much debt do you have?
  • What sort of debt is it – loan, credit card, mortgage?
  • Are you spending more than you earn?
  • What is the value of your assets (savings, investments, cars, home, etc)?

The best way to get a picture of your financial situation is to create a budget, where you can work out your spendings & earnings and record in one place the value of your assets and the value of your debts.

Creating a budget is very simple and you can click on this link to download a Free Budget Template.

Step Two – Create Your Debt-Free Strategy

The strategy is simply a plan for clearing your debts.  With the budget completed, you now know where you are, you know that you want to achieve a debt-free lifestyle and now you just need to plan how you get there.

How you create your strategy is really determined by your own debt situation, but there are some common themes that apply to many debt situations:

  • Spending more that you earn – this is often the biggest cause of debt and should be one of the first items that you address in your strategy.  Look for ways to cut your monthly expenses, so that you are spending less than you earn – click on this link for some great Money Saving Ideas and even if you are already spending less than you earn, it does not hurt to cut back and use the extra cash to reduce you debts.
  • Pay off expensive debts first – Money borrowed on credit cards and store cards tends to come with much higher interest rates than bank loans.  Try to prioritise your debt payments so that you pay off as much of the expensive debts as possible.
  • Use savings to clear debts – People often have money held in savings, whilst owing large debts.  The problem with this is that the money earned from interest from a savings account is generally much lower than that owed on a debt.  It is better to use your savings to either clear or reduce the amount you owe.

Your Debt-Free Strategy does not need to be complicated and could just be a one-page document covering the following items:

  • The goal that you are trying to achieve (to become debt-free) and a realistic date for when you want to achieve this by
  • A list of your debts, including the value of each debt
  • Priority assessment of which debts need to be cleared first (e.g. your credit card is likely to be higher priority than your student loan)
  • How much money you are going to repay on each debt every month
  • Any savings or investments that you can cash in and repay against one of your priority debts
  • Any assets that you can sell to raise additional money to help clear debts (e.g. trading down to a cheaper car or items around the house that could be sold on Ebay)
  • Any activities that you can undertake to reduce your monthly expenses, so that you are spending within your means, resulting in extra cash to help clear debts
  • A timeline to show when you expect to implement all these activities

If you need help to create your strategy or want advice about coping with more serious debt issues, then visit this debt advice guide page from the Citizens Advice Bureau.

Step Three – Monitor and Control Your Debt-Free Strategy

The final step is to implement your Debt-Free Strategy and keep in control of it.  It could take two or three years before you have cleared all your debts and you will need a good level of self-discipline to ensure you stick to the strategy.

Your budget is your key tool for monitoring and controlling your debt repayments and you should get in the habit of updating it and monitoring your spending at least once a month.

Next Step – Grow Your Wealth

Once you have paid off your debts, the next step is to use your new financial management skills to begin growing your wealth and ensuring that you never get into debt again.  For more information take a look at The Rules of Financial Freedom.