Step 0: Get out of Debt

TL;DR: Debt is horrible (for most people). Make a plan/budget, pay it off, move on with your life. If you’re really underwater, search for help sooner rather than later.

Ok, maybe it’s not exactly that simple. While debt is amazing if used properly, in most contexts it’s a huge burden.

For most people, debt can weigh you down and destroy your life’s savings/retirement plans. We want to avoid that.

Pay attention to your interest rates

The main benchmark is inflation, which is about 2% in the US. If you’re able to borrow money below 2% and using it opportunistically, you basically got free money. However, most of the time you’re borrowing at rates much higher.

When it comes to credit card debt, that can be in the range of 20-30% or potentially even higher. DO NOT FALL INTO THAT TRAP. This is an absurd rate and you want to avoid this whenever possible. While credit cards are a powerful vehicle for rewards, cash back, and convenience, it is so important not to carry a balance because you will pay an arm and a leg in interest.

You may also have car loans, or student loans, healthcare bills, etc… And it shouldn’t take too long to find what interest rate you’re paying on these debts. Look on the website, or call and ask. The general rule of thumb is you want to pay off the debt with the highest interest rates first to avoid the most charges. If you can catch promos where credit cards while offer 0% interest for a while or something, do it if you have to.

While there is an argument to take on debt if you’re investing in something with a higher rate of return, for the most part if you’re the average Joe, just pay off your debt. Please. Do whatever you can to do so. Which brings us to the next step.

Make a budget

To pay off your debts, act now to make a plan. Look into your finances – how much is your income, and how much are you spending? Make a plan for how much you’ll need to survive and my advice would be to be very frugal. If you have high interest debt right now, it’ll pay handsome dividends (i.e. you’ll save so much) if you pay it off now rather than later.

There is a symmetry where paying off your debt now (e.g. your credit card debt at 27% interest) is mathematically equivalent to investing in an amazing investment that returns 27% interest. You could think of it that way if it encourages you pay off your debt.

Please pay off your debt before thinking of splurging on anything.

Personal Capital is what I use to keep track of my budget. It’s an amazing tool to see how you are doing financially. My recommendation would be to sign up, link all your accounts (not just the ones that look healthy), and you can explore how your expenditures are (under the cash flow section). You can get an idea of how much you can cut down on spending, and how much more you can contribute to paying off debt. If you’re really in trouble, analysis at this stage will let you know sooner rather than later.

In general, look at your needed monthly payments on all your debt vs. how much you can pay off here. If your monthly payments on your debt is higher, you’re going to have to make more drastic plans.

Collection Agencies

At some point in our lives, almost everyone has to deal with a collection agency. I certainly have. Whether it was a misunderstanding or if you’re in real trouble, it’d be good to get a heads up on who you’re dealing with.

The simple version of a collection agency’s business model is as follows:

Company xyz (e.g. the hospital) has a bill from a customer (you), and the customer has not paid for a significant amount of time.
Compnay xyz gives up on the bill (e.g. a full $1000 bill) that the customer owes, and sells the debt to a collection agency for a fraction of the price (e.g. $100) to recoup at least some of the bills.
The collection agency will hound the customer to pay the full bill in any way possible, and collect the profit (e.g. $900).

In general, collection agencies are not on your side and offer extremely poor customer service. They are there to extract money from you and don’t care what your story is or what they need to do.

They are very aggressive.

Be prepared to deal with these calls and know your rights (a simple Google search would give you something).

While there are no guarantees (I’ve never tried it personally), rumor is that because the collection agency bought your debt for a fraction of the price they’ll also settle for you paying a fraction of the debt. That’s something to explore.

Declaring Bankruptcy

Sometimes the debt just becomes too much, and you need a fresh start. Bankruptcy is a way to go, which will in some cases, relieve you of your debt.

Just know there are many costs to this. Ironically it’s expensive to declare bankruptcy. Your credit score will definitely get hit. It’s also said to be a dreadful process.

If this seems like your only option, please seek professional help (which I am not).

Is Debt Always Bad?

So far I’ve made debt seem bad. However, that’s not always the case. When used properly and responsibly, there are cases when debt can be amazing.

Credit card debt (for the first month, but make sure you pay by the due date) can build your credit history, give you rewards, and essentially let you hold on to your cash a little longer so you can earn interest on it (even if it’s just for a month).

Mortgages on houses, student loans, are all investments in your future. These often offer low rates that are worth it if you have a plan to sustainably pay it off in the future.

Getting business loans for a great idea can also be great if your risk-adjusted rate of return on your business is higher than the loan rate. This is a way to leverage your returns. Just be careful.

Just know debt has to be used responsibly, and if you’re not at that stage of your life yet, just avoid it altogether if you can.

Happy debt-freeing!

TheJKW