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How to Get Out of Debt - Our Story

Written by FrugalTrader on Aug 4, 2008 filed under debt

If you read the about me section, you might have come by an article that explained where we financially started upon graduation from University. To summarize, we were majorly in debt (but not as bad as these guys). To start, we had a large student loan along with a brand new car loan. Within 4 months of that, we closed on our first home/mortgage with no furniture along with an engagement ring in the works. So needless to say, there was a lot of money spent. The bad part was that it was with mostly borrowed money.

I don’t write a lot about debt as I personally believe in focusing on building wealth instead. However, dealing with debt is a big part of personal finance. We managed to pay off $50,000+ worth of student and consumer debt in 3.5 years after graduation all the while maintaining a principle residence, purchasing a rental property and getting married. In fact, we could have had our debts paid off sooner if we didn’t build a large cash emergency fund.

How did we get out of debt?

Here are there guidelines:

Be committed to reducing your debt. Focus and set your mind to creating wealth by reducing debt liabilities. This must be top priority before any discretionary spending or even retirement savings.
Calculate and increase your cash flow. Track your income and expenses to figure out your cash flow. If your cash flow isn’t positive after all expenses including debt servicing, find ways to reduce expenses and/or increase income until you have a positive balance sheet. The higher your positive balance, the faster the debt will be paid off. For the most of us, saving money is easier than finding ways to make more money. We did both - we lived frugally and I got a second job.
Extra money is used to pay for beer down debt. Any excess cash flow from your budget should be used to pay down debt including unexpected income ie. higher than normal tax returns etc.
High interest debt is paid first. Debt should be paid off in this order of the highest interest rate -> lowest interest rate (after tax deduction if there is one). Minimum payments should be made on the lower interest rate loans, while pouring all excess cash flow on the highest rate loan.
Keep it going. Once a loan is paid off, take the old loan payment money and dump it on the next highest interest rate loan. Repeat until all debt is paid off.

If you have consumer debt that you want to get rid of fast, then follow the steps above and you’ll be debt free much sooner than you may realize.

For those of you who have also defeated consumer debt, how did you do it?

32 Comments, Comment or Ping

1. Think Money Debt Blog

Just wondering why you chose to build an Emergency Fund while you still had debt to pay off? I know many people would choose to get rid of the debt asap & then build their savings.

Care to elaborate?

Aug 4th, 2008 @ 7:42 am
2. FrugalTrader

Hey TMDB, thanks for stopping by. If I had my time back, I would have paid off the debt even earlier. However, I still have the preference to build assets than to reduce liabilities even though in the big picture they both do the same thing, increase wealth.

Even today, I hold quite a large cash reserve in the case of a “bargain” real estate or other investment opportunity.

Aug 4th, 2008 @ 7:49 am
3. DAvid

I would also recommend converting high intrerst debt to lower interest debt, and keep paying it at the same rate. If you can transfer your credit card debt to a LOC, you can more quickly reduce your debt.

DAvid

Aug 4th, 2008 @ 9:37 am
4. FrugalTrader

Good call DAvid. We didn’t have any obscene interest on our debt, so we didn’t make any transfers. But your advice is spot on for people carrying credit card debt.

Aug 4th, 2008 @ 9:50 am
5. Dividend Growth Investor

Thanks for the summary FT. Very few 20 something year olds have the discipline to get out of debt. The pop culture tells them that in order to “be cool” and be happy you have to spend a ton of money on the latest clothes and gadgets, while charging it on your Visa/mastercard. It’s fun :-)
Why should I go through all the hassle of figuring my expenses when I can simply open a new credit card and live like a king?:-)

Aug 4th, 2008 @ 11:47 am
6. canabiz

I am sure a lot of financial-savvy folks like you guys already know but in case you guys are not aware: MBNA and CitiBank currently offer 0% balance transfer for a minimum of 12 months. Certain conditions and restrictions apply, as always, but it’s a neat way to get rid of those high interest loans and to get your finances in order, so to speak.

There are various threads discussing these *deals* on RFD, I am sure you guys can find the information in no time.

I am also not big on spending large sums of money to earn rewards. The points are something I consider *nice-to-have* but they are not nice anymore when you fall behind on the payments and incur interest as a result. I guess the banks don’t throw us the bones for nothing, they are in the business of making money and at the end of the day, it is ultimately our responsibilities to look after ourselves.

Aug 4th, 2008 @ 11:53 am
7. MoneyGrubbingLawyer

Another great post, FT. I tend to focus, as you do, on accumulating wealth rather than eliminating debt, but your tips are certainly helpful.

My biggest strategy for paying down debt has been regular, automatic payments against my debt. Much like the “pay yourself first” strategy of having a certain percentage of your pay automatically put into savings, I have automatic payments that go on my debt every payday, in addition to the required monthly payments. The amount I pay is based on my budget and reduces the temptation to take it and spend it elsewhere. This approach has allowed me to make great progress in paying down a huge student debt.

Aug 4th, 2008 @ 4:04 pm
8. The Financial Blogger

I think that your focus on your goal is the best way to achieve it.
In order to get rid of our debt faster, I got a second job and that extra income was going exclusively on our debts along with our regular payments.

Having a second job was good for two things:
#1 using extra cash flow to pay down our debts faster by applying extra capital payments
#2 Since I was busy working more, I had less time and less energy to spend my money :-) This is a great way to save money :-D

Aug 4th, 2008 @ 6:25 pm
9. Raymond Caxton

The crucial part of paying off your debt is making a plan. Once we make a plan for getting out of debt, we can start doing what it takes to live our life debt-free.

Aug 5th, 2008 @ 4:49 am
10. Cannon_fodder

Why aren’t these things taught, nay drilled into, teenagers? Which ultimately will benefit them more - reviewing Shakespeare’s Romeo and Juliet or money management?

Aug 5th, 2008 @ 2:01 pm
11. Gates VP

TMDB: Just wondering why you chose to build an Emergency Fund while you still had debt to pay off?

I think this really ventures in to the oft-unexplored reason of “financial reality” vs. “financial idealism”.

It’s like the “snowball method” of debt repayment (where smallest debts are paid off first). Numerically, it does not make sense to pay off anything but the highest interest rate debt. However, humans are not governed solely by numerical reason. The psychological effects of paying off any debt (even the smallest) can actually increase the chance of future payments happening.

In the case of FT’s Emergency Fund it makes little sense “in the abstract” to save money while debt is owed. (Of course it’s done all of the time with great reasons: mortgages, car loans, student loans, business loans, items that are leased, etc.) But in reality, maintaining a cash balance is important.

Life doesn’t always take credit.

In the ideal, you should be able to throw every extra penny at “the debt”, but in reality we know this simply doesn’t work. You have to float money in the account to cover bank fees, you forgot about to plan for the car insurance and they don’t take credit, you have a medical emergency (here in the US) and they only take cash, your house is broken into and you need to pay the deductible in cash, your boss’s pay-check bounces (yes I’ve seen it happen). Most rental places won’t let you pay the rent with anything other than “cash or equivalent”. (yeah, some people have those “Mastercard checks”, but that kind of defeats the purpose)

I knew one lady going through credit repair and the “repair specialists” simply sucked up every dollar she had. She had to fight to keep a few “uncontrolled” dollars around. When her kid got sick and needed cough medicine (but had no budgeted case for it), it became apparent that you couldn’t cut it quite that close.

And there’s something uncomfortable about sending out a Credit Card payment and then losing your job, only to realize that you won’t make next month’s rent (even if you find a job before then).

So, yes, in theory, you should always pay off the debt first and ignore the “emergency fund” for the “actual emergency” of the debt. But in practice this simply doesn’t work.

Aug 5th, 2008 @ 6:41 pm
12. Nate

Hey FT,

Just wondering what you think of schemes for paying off debt like the MBNA 0% credit cards that are often discussed over at Redflagdeals? I was considering transferring my student loans to an MBNA card, but I’m having trouble convincing the Mrs. She’s not a big fan of loading up a creditcard.

Aug 5th, 2008 @ 10:57 pm
13. FrugalTrader

Hi Nate, I think the idea is fine providing that you can pay the CC balance in full when the time comes in 12-15 months. Is that what you had in mind?

Aug 6th, 2008 @ 12:09 am
14. Nate

Yes, the plan is to pay it off before we pay interest. Unless we go for the 2.9% lifetime interest rate they are offering now. We would basically be consolidating in that case.

The 2.9% deal information can be found here: http://www.redflagdeals.com/forums/showthread.php?t=618353&page=1

Aug 6th, 2008 @ 1:12 am
15. gail

Hi FT,

I’ve been following your site for awhile, and I have become quite appreciative of the information — it’s inspiring! The only debt I currently have is a mortgage (and a HELOC for the Smith Maneuver). But when my husband and I met, he had a bit of credit card debt, and thousands more in student loans.

First, we threw money at the credit card debt, ASAP. He also bought a different car, instead of a gas-guzzling truck) which helped significantly. Then, we secured a home line of credit to include all of his student loans (property value had more than doubled at the time).

Not really rocket science, but it was an extremely stress relieving thing for him, as there was no way to consolidate his loans previously. It was tiring to ensure each lender was paid their piddly amount (and frustrating knowing how little the debts were being paid down!). To make matters worse, he missed out on any student loan relief because every year he went to school, the government lending body changed making it appear to each one that his loans were not significant.

As a student (university for 9 years!!) I found that also trying to time my shopping with my credit card rollover date was helpful. For example, I might wait a day to purchase groceries and the bill wouldn’t be due for perhaps another month versus the next week … when I knew I wouldn’t have the money. This helped to keep me from ever paying interest on the card. Timing is everything.

The key is to be diligent about paying down debt, and to spend the time and energy learning what things really cost.

Aug 6th, 2008 @ 11:27 pm
16. Writer Dad

Getting rid of the debt is so important. If you don’t, it will swallow you like the hungry alligator it is.

Aug 15th, 2008 @ 3:54 pm
17. Novice

@ 10 Cannon_fodder

RE: “Why aren’t these things taught, nay drilled into, teenagers? Which ultimately will benefit them more - reviewing Shakespeare’s Romeo and Juliet or money management?”

While I understand the sentiment (but not why it has to be one or the other), some 400 years after he lived, Shakespeare will still benefit them more.

Solid Financial and life advice from Hamlet:

“Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.”

Sep 8th, 2008 @ 12:19 pm
18. T.B

Hi,

I am considering rolling all of my (and my wife’s) debt into my mortgage when it comes up for renewal. We have approximately $30K in credit card and LOC debt. Would you recommend this as a strategy for reducing debt?

Don’t worry, we’ll be structuring ourselves so we don’t use our cards anymore for useless purchases…

Sep 9th, 2008 @ 3:24 pm
19. FrugalTrader

T.B, providing that your mortgage interest is lower than your credit card interest then it should be a good plan. That is provided that you follow your plan of getting rid of those cards.

Sep 9th, 2008 @ 4:42 pm
20. Cannon_fodder

Novice,

There is no chance of you convincing me that learning Shakespeare will actually benefit the average individual more than being educated about personal financial management.

I have yet to see a study listing the top 10 reasons for relationship breakdown that listed lack of knowledge when it came to the Bard. Financial issues? Usually in the top 5.

Nor, do I remember being asked to quote a sonnet during my mortgage application. My credit score? Absolutely. For my wife and I, because we are good at managing money, owning a house with borrowed money, has been a very good thing for us.

Sep 10th, 2008 @ 6:32 am
21. Gates VP

I have yet to see a study listing the top 10 reasons for relationship breakdown that listed lack of knowledge when it came to the Bard.

Of course, there may be some conflicting data here. In my experience, the ability to manage money shares many attributes with the ability to manage one’s health, relationships and careers. (Yes there are some exceptions).

In the case of a relationship breakdown, money is often a prominent factor, but it’s typically just the most visible end result of the relationship damaging decisions. Spending money to cover unhappiness, shared delusions of an unaffordable lifestyle, financial “cheating”, these are all relationship issues that manifest themselves as money issues.

Sep 10th, 2008 @ 1:23 pm
22. Novice

Cannon Fodder - To understand Shakespeare is to understand the human condition - anger, jealousy, love, happiness, sorrow, grief and all that exists between heaven and earth. If you really understand your partner and yourself, then you will have a much higher likelihood of achieving a successful and balanced relationship.

To build upon Gates well-put observations, I highly doubt that those youngsters who do get into ‘money problems’ do so because they do not understand how to calculate the APR they will pay; they spend poorly or make bad decisions because they do not understand who they are or why they are engaging in such harmful behavior.

I would also surmise that anyone educated in Shakespeare will have a surprisingly strong interest in personal finance as well, given that so many of his characters are motivated by wealth - Iago, Richard III, Macbeth.

I’m not suggesting that teaching personal finance isn’t a great idea (of course it is) but that there is value in learning both.

As to the rest of your post - ie “Nor, do I remember being asked to quote a sonnet during my mortgage application” is true and a fair point, but the problem is that the same logic can be used to dismiss most of the high school experience. In my own mortgage application, I wasn’t asked to use the quadratic equation, list the Newtonian laws, speak Spanish, or run laps - so by your logic then algebra, physics, other languages, or physical education have no bearing or use in the real world either as long as you can own a home with borrowed money.

Sep 10th, 2008 @ 4:05 pm
23. DBennett

Last year this time I had about $3,000 in debt. Mostly on credit cards and paying for things like rent. Being a university student, with no student loan debt, entering my 3rd year (last year), 3k in debt wouldn’t be considered bad. However, I’m not a fan of it. Being a business student with paid work terms, I only made $12 an hour and worked another job about 6 hours a week. In the mean time, myself and my SO booked a trip to London and Paris that cost around $3k. Even with rent, bills, car payments, insurance, and tuition, I managed to pay off all of the debt last month. (My work term pays $12 an hour this time as well). In addition, I have enough money saved to pay for next semester’s tuition as well as having $6,000 in investments (that have dropped considerable recently I might add).

The moral of the story here is that, if I, a university student, can pay off $6,000 and invest an additional $2,000 all while making less than $12.50 an hour, in a year, its possible to stretch your money further.

Nov 25th, 2008 @ 12:56 pm
24. Time to get serious

Hi, can anyone recommend “FREE” software or a spreadsheet to help start tracking expenses so I can get serious about my cash flow issues and focus on debt retirement - lots of great ideas here and I’m ready to commit!!!

Jan 2nd, 2009 @ 3:08 pm
25. DAvid

There are lots of spreadsheet templates to track budgets and expenditures. Just do a web search for “personal finance templates” or “personal budget templates”. You might also wish to have a look at Abassis Software’s product.

DAvid

Jan 2nd, 2009 @ 4:38 pm
26. Baywen

Good afternoon. I am involved in the real estate industry in BC as an unlicensed marketer of various developments. As a startup I have utilized credit card(s) to get myslef going over the past year.

As I have not been making income tax deductions throughout the year (yes it was foolish, I know), I will have that to deal with as well.

I have split my income with my assistant so that both of us have earned roughly $50,000.

Currently I have roughly $20,000 in debt and with roughly $70,000 of room for RRSP.

My mortgage is roughly $210000 with a home value of $425,000.

As I have $18,000 coming into my pocket over the next couple of days, I am looking for some options from readers as to how I should proceed. Pay off dedt, do Sm in some fashion, RRSP’s???

I am completely ignorant of the financial aspect of things and my advisor is not a hands on type of guy and is going to be replaced.

Looking for genuine input.

Thanks

Jan 9th, 2009 @ 5:57 pm
27. Scott

Use $20,000 to PAY DEBT!

Never question or second guess debt reduction — especially credit card debt!

You have about 4 months to come up with your ‘08 ‘tax-owed’ money. Even then, you may be able to pay that on installments, but still cheaper than a CC (assuming an average CC rate).

Jan 10th, 2009 @ 12:23 pm
28. Gates VP

@Time to get serious

The easy on-line option is Google Docs:
http://docs.google.com/

If you don’t want the “on-line version” then check out Open Office, the freeware, open source competitor to MS Office:
http://www.openoffice.org/
In particular you’ll want the Calc program which should look quite familiar (screenshot here).

Jan 30th, 2009 @ 1:10 am
29. Novice

@ Time — my experience has been that the best way (for us, anyway) is simply a notebook and pen. For each month create 8 - 10 categories (ie house, investments, utilities, misc) and each day update the book with what you spend in each category, and at the end of the month see how you did versus the budget. We tried using excel sheets etc but it was just easier at the end of the day to write it in a book than to go downstairs and enter it in. Not the most high tech way to do it but it works, especially if you want to see the little things you buy in cash (ie subway tokens).

Feb 2nd, 2009 @ 2:22 pm
30. Debt Consolidation Regina

Great article! Short yet informative on how to take the appropriate steps in order to manage your current debt and avoid it in the future.

Apr 27th, 2009 @ 12:46 pm
31. Toronto Bankruptcy Trustee

To the point, simple and concise. This article may detail some of the obvious solutions to debt but people often find it difficult to carry out these easy steps. It all starts with the will power as said in step 1.

May 21st, 2009 @ 12:40 pm
32. Jeremy

Google the “Pear Budget” spreadsheet if you’re looking to track monthly household expenses. (Make sure you download the free excel version, not the online version).

Also a note about consolidating debt on in a mortgage:

“Consolidating debts into your mortgage, or another secured loan is (again, in my personal option) an even worse idea. Secured debt means that if you default on payments you’ll lose your home. Not only that, but your mortgage will generally be on a much longer term, so although the interest rate may be less, in the long run you’ll be paying far more.

For example, according to the figures you’ve just entered, you currently owe $30,000.00. If you consolidated that into your mortgage at, say 5.5% over 25 years, you’d end up paying $25,267.87 in interest. By snowballing correctly, you’d pay $4,247.00″

link: http://www.whatsthecost.com/snowball.aspx

May 25th, 2009 @ 5:29 pm