I often refer to debt as a “spiral of debt” because one small thing leads to the next and you slowly but surely get wound up in huge amounts of debt that eventually pull you down like a whirlpool. I’ve been thinking about it though, surely one can reverse or unwind the problem to get back to a debt free state. I know it’s possible because I did it and lived completely debt-free for a few years (until I needed a home loan to buy my house – perhaps I should make a post on that). So let’s look at how we get into debt, and then how we can work our way out of debt.
Disclaimer: Getting out of debt is definitely easier said than done! There is no magic formula and it can often take a few years of focus and dedication. But, it is absolutely possible!
How do we get into debt
You may be thinking “how on earth did I get into all this debt?” and it’s actually quite easy to understand. Everyones story is different, but in general it happens something like this.
You get a job and are earning a bit of money when you decide you need to buy a car. But you don’t have cash so you take out a loan. However, the bank won’t loan you money for a car that is too old so you feel “forced” to buy a newer and more expensive car and the bank obviously tells you that it is affordable. And so the spiral has begun.
Because now you’re paying a monthly instalment on your car and probably don’t have much (if anything left) of your salary so if anything major goes wrong with the car you would need to use credit on your credit card. Luckily though the bank has foreseen this and have already offered you a credit card with lots of credit (because apparently you’re really good at managing your money).
But now other things come up like eating out at a fancy restaurant to celebrate a friends birthday. You don’t actually have the money but feel too embarrassed to say so, thus you use your credit card. And then you look at all the designer labels your friends are wearing and feel that you need new clothes. You use the credit card. And then the new TV, overseas holiday, etc… once you have debt and simply pay the minimum amount each month you somehow feel that it’s manageable and you keep spending. And once the credit card is maxed out you either request more credit or you get a new card.
It’s a bit scary the first time you borrow money and get into debt but it just gets easier and easier. And it’s so easy to always think that next month will be better or that living off your credit card is only a short-term solution. The reality though is that unless you completely stop using your credit card, you will most likely rack up new debt each and every day and when it comes time to pay, you are not only liable for the last months spending, but probably the months before too! And with an interest rate of around 25% you are potentially paying 25% more for each and every item that you purchase!
(Credit cards aren’t necessarily all bad, have a look at the pros and cons of credit cards)
How to get out of debt
So now that we know that debt builds up over time when we form the habit of using credit cards and loans, how can we rewind the process and get out of debt?
As mentioned in the disclaimer at the top of the article; this is far easier said than done; but it is completely possible with some focus and dedication!
1 – Stop making new debt
This may actually be impossible for you in the first month or two, depending on your circumstances though. However, you need to stop making new debt; thus no new loans and no new credit cards and no spending on your credit cards or overdraft account.
If you are so far in debt that you literally have no money left after paying your existing debt payments then you really need to stop spending money! It seems simple to say but it is harsh as you obviously have some basic needs to fulfil. You may need a month or two of really drastic measures to build up a small amount of positive cash flow (see why cash flow matters).
So as far as possible do not take any more new debt unless absolutely necessary. It is really hard to catch up to a moving target!
2 – Understand your current situation
Analyse all your bank accounts, credit cards and store cards and make a list of absolutely everything you owe. Also include personal debts from friends or family and highlight urgent accounts where you may be overdue on payments.
If you don’t yet have a personal or family budget then use these 5 steps to create a budget.
It may look terrible and be quite depressing but it’s important to acknowledge and understand your current situation.
3 – Decide where to start
Looking at all your debt you need to decide which one to pay off first. You will obviously need to make payments towards all your debts each month but decide which one can get a little extra each month (even if it is only R100).
To help you decide, an overdue account for which you are getting nasty letters in the mail is probably a good place to start. If you don’t have an account like that then see which one charges you the highest interest rate and fees as that is a good candidate. However if you have one debt that is really small and that you can pay off in 3 – 4 months, choose that one and get it closed.
Focus on paying off one debt whilst maintaining the payments for the others.
4 – The snowball effect
Once you have paid off one debt, don’t think that you have extra money. You should use the money that you were paying towards the debt towards a different account.
Let’s say you owe R20,000 on “Credit Card A” and currently pay R600 a month and on “Credit Card B” you owe R400 with a R100 payment. As soon as you have paid off “Credit Card B” you now take the R100 payment that you were making + the extra payment you were making and pay it all towards Credit Card A. This way you will pay the next debt off a while lot quicker!
Then once the second debt is paid you can take the money you were paying towards the first two debts as well as the extra amounts, and focus on your third debt. You will see how quickly the debt gets paid! And along the way, close the accounts fully to remove temptation.
5 – Budget & Balance
Focusing all your efforts on paying off debt can be very hard and it’s quite a balancing act. No matter how focused you are, real life happens and you car will break down, something at home will need replacement and school fees will go up. You know what I mean? Life carries on and throws curve-balls at you and it’s hard to stay afloat.
When things go wrong, reassess your finances and decide on priorities. Instead of feeling overwhelmed and giving up on the progress you’ve made, focus on what is needed and change your plans accordingly.
It will really help if you have an Emergency Fund but it is tricky saving towards an emergency fund while you’re focusing on paying off debt. There is unfortunately no magic formula of how to do it all. You just need to decide what is possible within your own circumstances and figure a way to make it all balance.
Being debt-free is a major element of financial freedom. It will eliminate stress and will give you so much more freedom with your finances. Going through the process of paying off all your debt will also help you understand your priorities in life and help you to make better financial decisions.
Being debt-free is amazing and wonderful! It’s completely possible and you just need to start with baby steps. Small and constant steps towards paying your debt will gain momentum and become easier and easier each month.
It’s possible, just make a plan and start!