Sunday, December 9, 2007

Debt Reduction Strategies That Work

If you're in debt, you know that something has to change. However, it can be difficult deciding where to start. It's generally obvious that going out (movies, dinners, drinks with friends, etc) is the one of the first places you can start.

I've paid off 40% of my debt in the last six months, and these are some of the things I've done to make that happen:

1. Live with roommates. I pay a fraction of what anyone else I know pays for their mortgage, and I'm able to use part of that money to help save for buying my own property in the future. Because I have roommates, all the house utilities are split, which saves even more money. The money I save on rent is a significant factor in me being able to pay more than the minimums on my bills.

2. Create a budget. This is the most important step to take. A friend helped me create a budget spreadsheet, and then I customized it greatly. As a freelancer, my clients pay me weekly. Each week, I know exactly how much money goes where, and it easily keeps me on track. I forecast what I expect to make throughout the year, and that information goes to a unique workbook, and can easily be compared to what actually happens. It's wonderful when I work more than planned in a week, and I can see larger-than-expected payments going to my bills and savings. I will write more about my budget spreadsheet in another post.

For anyone interested, email me and I can send you the basic spreadsheet that I use.

3. Follow the budget. This may seem like a no-brainer, but it's not. Keep yourself accountable. Be dedicated in going to the spreadsheet each payday and making your payments. For me, it got addictive to do this. It can be difficult at first, but there are specific and very tangible rewards in watching your debt go down on a regular basis.

4. Don't get more debt! Stop carrying your credit card. Know exactly how much you have left in your checking account for your week's pocket money (better yet, have it as cash in your wallet). If you don't have the cash in your pocket, you can't have it. Period. Use the credit card only for true emergencies that you can't cover from your emergency fund (e.g. unexpected dental work, car breaks down, basement floods). Emergencies do not include buying a new winter coat "because the one I have is sooo last season!" or replacing a cell phone just because a new version is available.

5. Don't create unnecessary debt. This goes along with #4. Use what you have. If you're like most people, you have far more clothing than you actually wear. I always used to think I had such a small wardrobe, and then when I returned from my first trip to Europe (two months), I was amazed at what I had. I'd been living out of a backpack for two months, and wore the same three or four outfit combinations the entire time.

If you simply want what is new, ask yourself "Why?" Do you really need a new computer with 200 gig? If you really need the extra space, consider getting an external hard drive instead. Look for frugal solutions before spending money.

6. Be frugal. I frequently shop in stores like Ross, Goodwill and Value Village. At Ross, I generally only look at what is in the New section, and I've seen several high-end brands, in addition to high-quality fabrics. Unless I need something specific and I can't find it in a second-hand store, I generally won't buy it new. The main exception to this is generally shoes -- though, I have found new Kenneth Cole heels at my local Value Village. I've repeatedly found un-worn, new clothing, in addition to great finds such as Seven jeans for $19, and a 2-ply cashmere cardigan for $15.

If your city has a craigslist forum, use it. I've bought and sold items in my city, and I'm repeatedly shocked at the quality (high) of items that some people give away in the Free category.

This is another thing I'll write more about in a separate post, but learn the difference between cheap and frugal. Buying three acrylic sweaters for $5/each is not a better deal than buying the cashmere cardigan for $15. The cashmere (or wool or cotton) will last significantly longer than acrylic. Frugality involves finding quality at a low or reduced price. Cheap is just paying as little as you can get away with -- which generally means you spend more in the long-run.

7. Don't become a miser. Yes, debt reduction is about saving money in other things, to pay for what you've bought previously. Don't let yourself get sucked in to depriving yourself, though, or you will begin to resent what you're doing and probably stop doing it. Go to dinner with friends (a few times a month, not a few times a week), go to the movies, [once a month] spend $25 on something unnecessary.

Like with dieting, actively paying off debt requires finding the right balance for the individual. Some people I know would never consider living with roommates, and for me, this is the one greatest save I made in my monthly budget (I pay less than 50% of what it would be for me to live alone). If you can't do this (or if you have a family), find other ways. Get rid of the second car. Carpool. Plan your grocery trips around menus. Start a children's clothing exchange. Tell your friends and family what you're doing (but don't tell them how much you're in debt, because that is not their business), and ask that they ask how you're doing (this helps keep you accountable). Find a resource that helps you stay on track (e.g. a personal finance book, a blog). Also find someone you feel comfortable to talking with about finance topics.

Debt reduction can be a Big Scary Thing, but if you approach it with a sane plan and recognize that little changes make big dents, it becomes a lot easier.


Rob in Madrid said...

I agree, the smartest thing you can do is not add more debt, seems like a simple thing but harder to follow. I would add lessons learned from previous disasters. View what you did right and wrong

Jen said...

Great advice! Sticking with a budget is the most important - and most difficult - thing to do.

I disagree with not carrying your credit card, though. I think that you should always have one credit card with you and use it only for emergencies. You don't know when you're going to be stuck somewhere and need it. It's not going to help if it's at home in your drawer.

Aaron Stroud said...

One strategy I'm using to get out of debt is remembering that every purchase I make is with borrowed money.

I believe the natural state is to be debt free.

So, when you spend a dollar on something instead of paying down debt, you're essentially deciding to continue borrowing that money, so you can buy this new thing.

This frame of mind is helping my wife and I aggressively pay down our mortgage.