Personal debt has long had a stigma and for good reason: owing money to credit card companies, lenders and other businesses leaves you saddled with required payments for the indefinite future, and on top of that, you’ll pay compounded interest that end up totaling many times more than what you originally borrowed.
The average American household’s credit card debt alone in 2016 was more than $16,000 — a number that balloons every year and prevents millions from building the financially stable life they desire.
While there are forms of good debt, too (think mortgages), but most personal debt is something that should be paid off as soon as possible. Making minimum payments, month after month, might seem like a reasonable way to salve your financial pain, but there are much better ways to approach your existing debt.
Step 1: Prevent Any Further Accumulation
Your first job is to stop yourself from accumulating any new debt.
Reserve your credit cards only for emergencies; if you have trouble maintaining self-control, consider paying only cash for your goods and services. The tangible feeling of parting with cash makes consumers spend less — plus, you’ll be less tempted to use your credit card.
Of course, you may be in a tight financial situation that forces you to use your credit card to get by; fortunately, the next three steps on this list will help you through these circumstances.
Step 2: Make a Budget and Prioritize Debt
Next, make a personal budget. If you haven’t made a budget before, you can find a basic template online to help you create a framework. Make a list of all the income sources you can count on, and start allocating that income to three different expense categories:
- Regular, necessary expenses. These are things like your rent, utilities, groceries, and fuel, which you need to survive and must pay on a consistent basis. Some of these are fixed and some are variable, so do your best estimating your average monthly total here.
- Irregular, necessary expenses. Irregular but necessary expenses are things you need to pay predictably, but not every month, such as payments for doctor visits or car repairs. Set aside some money every month for these expenses, so you’re ready when they occur.
- Unnecessary expenses. These expenses are not needed or easily substituted with a lower cost option, and may include going out to eat and other forms of entertainment.
In addition to these sources, you should allocate as much money as possible to paying down your debt each month. Take care of your necessary expenses first, then your outstanding debt, and only then should you start budgeting to allow for unnecessary expenses.