Wednesday, October 3, 2007

Getting Out of Debt

A lot of folks have asked me the best, most painless way to get out of debt. Short of dying, the following works pretty well:

1) List all your debts, with the balance and the monthly payment.

2) Choose the one with the smallest balance.

3) Do whatever you must to pay off that one, small balance. Have a yard sale, or sell unwanted items on eBay.

4) Now use the money you save from not having that payment each month, and apply it to the monthly payment of the next smallest bill. For example, if that smallest bill used to have a monthly payment of $25, and the next smallest has a payment of $50, you would now pay $75/month toward that next smallest bill, thereby paying it off much faster.

5) Whenever you come into "found" money (unexpected overtime, selling an item etc.), apply those funds to that smallest bill.

6) When that second smallest bill is paid off, apply that $75/month to the next smallest, until it, too, is paid off.

7) As each bill gets paid off, use the savings to apply to the next bill.

You will find that it starts out very slow, but soon snowballs. Take a look:

Let's say you are making payments of $25, $50, $100, $120 and $150 per month on various debts, for a total of $445/month. Let's also say you are paying $1500/month on a mortgage.

By paying off the smallest, you now apply that $25/month toward the next bill, paying $75/month. When that bill is paid, you now add that $75 to the $100/month on the next bill. Eventually, you will be applying the entire $445/month toward the last debt (not including your mortgage). At that rate, that last debt gets paid off very quickly. You now have an extra $445/month to improve your lifestyle, or apply it toward your mortgage, taking several years off the term of the mortgage - and saving you many thousands in interest payments.

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