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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?

16 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