Be Financially Free – Lesson 3 – How to Get Out of Debt

In the last lesson (if you missed it or want to review it, click here), you calculated your "number".

With that "number", you now have a destination as you begin the road to financial freedom.

If you are starting your journey with a negative net worth (click here to learn how to calculate your net worth), you have your work cut out for you. The biggest reason for a negative net worth is usually ...

... DEBT.

It is important to distinguish between Good Debt and Bad Debt.

Good debt is when you borrow money to pay for things you NEED (Home, College Tuition and/or Car Payments) but can't afford up front without using up all your cash and selling out of your investments.

Bad debt is when you borrow money for things you don't NEED (IPad3, Trip to Tahiti, Luxury Goods, etc) and can't afford. Most credit card debt falls under this category.

No matter what type of debt you have, you should work to get out of it as fast as you can.

If you have a spending problem, the very first thing you should do is remove easy access to credit by cutting up all credit cards and closing any lines of credit. For those who only have good debt and can control spending, there is no need to cut up your credit cards.

If you don't have a plan to get out of debt, then most likely you are not going to get out. Fortunately, here is a simple and effective 7 step process that will help you eliminate your debt:

Step 1 - Organize all your debt by creditor, interest rate and minimum payment amount and sort by interest rate from highest to lowest.

Step 2 - If you are late on any payments, IMMEDIATELY call your creditor (personal or institutional) to explain. In many cases, the interest rates and loan terms can be negotiated.

Step 3 - Review your income and determine the LARGEST monthly amount you can use to pay off your debt. Remember to make sure you have an adequate emergency fund (1 year's worth of expenses).

Step 4 - Add $20 to every minimum payment on your list of debts and add up the final total monthly debt payment. You want to always pay more than the minimum if you are serious about getting out of debt.

Step 5 - Subtract the total monthly debt payment from the amount you allocated to pay off debt. If you have extra money, apply that to the debt with the highest interest rate. If you can't make the minimum payments, consider consolidating your debt to lower the minimum payments.

Step 6 - Make your payments according to your plan in Step 5 and adjust if income or situation changes.

Step 7 - Repeat Step 1-6

Although not advisable, you can take out a home equity loan to pay off your debt since the interest is tax-deductible and you can usually get a much lower interest rate than your credit cards. Of course, if you end up spending the money from your home equity loan on a trip to the Maldives and can't pay it back, you can lose your home.

Getting out of debt is never the solution. You must look at the specific habits that got you into trouble. Only by changing those habits can you truly take the next step towards being financially free.

"Think what you do when you run into debt; you give to another power over your liberty"

- Benjamin Franklin

Now that have made arrangements for your debt, let's get back on the journey with our next lesson.