10 steps on how to pay off debt with the income you have

I’ve had my fair share of struggles with debt. But the good news is that I have been able to pay off my debt and I know live debt free. Living debt free might seem like a big deal, but really isn’t it perhaps just going back to the basics of sound fiscal management? I think it is.

So in this post I want to share with you how to pay off debt with the income you have. This is how I did it. I didn’t go out and get a second job or use some fancy loans to pay off my debt. I paid off my debt with the income I was already earning and bringing home. This process will also work if you are looking at how to pay off credit card debt quickly. Because frankly, for many if not most of us, credit card debt is the debt that usually carries the highest interest so we’re going to make that our focus. The only other debt that might cause you some greater concern is if you have to pay off IRS debt.

A quick word about IRS debt. You need to take care of your IRS debt first because this carries huge penalties to the tune of a maximum of 25% as a failure to file penalty as well as a penalty of 0.5% failure to pay penalty that has no upper limit and continues until the full payment is made and lastly there is the interest fee of around 4% on any outstanding IRS debt that you currently owe.

So if you have IRS debt then I would make sure that is the first debt you focus on paying off. I didn’t have IRS tax debt to pay, but the general idea on paying off your debt quickly, easily and with the resources available at hand will work no matter what type of debt you need to pay off.

So please take a breath and collect your thoughts and lets get ready to find the best ways to pay off credit card and other debt. This worked for me, and I see no reason why you won’t be able to eradicate all of your debt and start living a more sane and fiscally responsible debt free life.

Step 1:
Make a list of all debts that you currently owe. I like to use a spreadsheet to make a list of the debts I had, but even just writing it out on paper will help. But you must do this. You need a visual representation and resource to refer to so you know exactly how much debt you have and how much debt you owe.

List the full amount of the debt as well as the minimum payment that you need to make each month. Also list the annual and/or monthly interest rate of each debt that you owe.

Now order all your debts first by highest interest rate to lowest and then by largest amount owing to smallest amount owing. So for example, if you have 2 separate credit card debts that both carry a 20% annual interest rate but on credit card A you owe $10,000 and on credit card B you owe $7,500 then you’ll list credit card A first.

Remember to include all debt even if it carries a 0% interest rate like my car payment did. List student loan debt, car debt, mortgage, IRS debt, credit card debts any type of personal loan debt and lines of credit. Be very thorough with this step and make sure you find all of your debts before proceeding.

Step 2:
When asking yourself if you should pay down debt or save, I always prefer and recommend the paying down of debt. If only because most debt carries much higher interest charges than you might earn safely by saving your money. But we’ll get to that in a bit.

Once you’ve completed Step 1 of your fast debt payment protocol as I like to call it, add up all of the minimum monthly payments that you need to make on all of your debts. You’ll know have a total minimum monthly debt repayment amount. This is the amount that you need to pay at a minimum each month if you are to stay out of defaulting on all of your debts.

Step 3:
Now you want to determine what your monthly expenses are for living. A lot of this you already know, because debt takes up a big chunk of our income. In fact I’ve read some figures that suggest that debt as a percentage of household income is around 150%+. This means that if you earn $50,000 a year you owe more than $75,000.

But that’s not the big problem as the amount needed to service that debt is likely only 20% to 30% or so of your household income. So itemize every expense you have each month for living. Gas, transit, food, eating out, clothes, makeup, toiletries, rent, insurance (car, home, life etc.) school, cable, phones etc, etc. You’ll need to spend some time with this to get it right, because you don’t want a surprise at the end of your first month trying to pay down your debt only to find that you’ve got to come up with an extra hundred bucks because you forgot about birthday gifts or something.

So your total monthly living expenses will include both your minimum debt payment obligations as well as ongoing life expenses to live your life. Add all of this up and you’ll have a total amount that we call your total expenses on a monthly basis.

Step 4:
Income. All these numbers are pretty red so far as we’ve only been talking about debt, which are negative numbers or show in red to indicate expenses. And now you’ve probably been crying and your eyes are mirroring the red on the ledger sheet 😉 Not to worry, we’re now going to find all of our income.

This might sound obvious but you should dig deep here as you might find some other sources of income that can easily be overlooked.

Obviously your paycheck is a source of income, but what about interest earned on any bonds or cash deposits you might have. Perhaps you enjoy a few bottles of wine a month and you take that to the bottle depot for a recycling refund, well don’t forget to include that as income too. It might only be 5 or 10 bucks but it’ll help.

The key is to add up all of your RELIABLE income sources each month. So that fifty bucks that Aunt Mildred sends you on your birthday I wouldn’t consider reliable as she might hold out this year.

Okay, so you add up all of your sources of income to come up with your total income for the month. If you get paid bi-weekly and some months you get 3 paychecks that can be a little trickier but you DON’T want to include that if you can help it unless you can budget for it.

Step 5:
Let the debt reduction party begin. You now know how much you earn each month and you know how much it costs you to live each month. We call these income and expenses respectively.

Take your income (which should be net income excluding taxes etc, or what you bring home income) and subtract from your income your total expenses.

Let’s take a simple example. I bring home $3,000 a month and all of my expenses including the minimum payments for my debts is $2,800 each month. This is terrific, it means that I have an excess of income of $200 a month. I have $200 extra spending money each month. But not so fast cowboy, we’re not heading to the casino, this money is going to go towards paying down our debt.

Now there might be a situation where some of you might have $3,000 monthly income and $3,200 monthly expenses. This means you’re falling behind by $200 a month or you owe more each month than you earn.

There are a couple of things you can do with this, and I’d suggest doing them both. First you need to cut down on expenses. As Dave Ramsey says, you need to go on a beans and rice diet. What this means is you’re going to trim down all the fat off of your expenses. So you’ll stop eating meat and you’ll buy dried beans at the grocery store instead of chicken breasts and T-bone steaks. You’re going to stop eating out and take peanut butter and jelly sandwiches to work for lunch. You’re going to become a no-name brand kinda gal rather than a Gucci gal.

The more you can trim from your expenses even if you have left over cash at the end of each month, the faster you’ll be able to pay down your debt. If you have 2 cars get rid of one. There are lots of things that can be done at this level to help free up cash. You’ve just gotta be willing to make the hard decisions.

If you drive to work you’re going to carpool or take the bus. If you have cable you’re going to cancel it. If you have magazine subscriptions you’re not going to renew them. These are hard decisions folks but I’ve been there and I’ve done it. If you listen to Dave Ramsey you’ll hear tons of inspiring stories of folks who have done it and they will inspire you to make the hard choices to pay down your debt as fast as possible.

You can also get a second job if needs be. Pizza joints very often need delivery drivers. Newspapers very often need folks to deliver the paper. And if you can speak English reasonably well you can sign up on Elance and bid on jobs to write articles for folks. Lots of internet marketers need articles written of around 500 words or so. If you bid 1 cent to 3 cent per word you should be able to pick up some gigs, especially at around 1 cents per word until you get some valid and helpful feedback.

Now a 500 word article shouldn’t take much longer than a half hour or so, you won’t get rich, but you could write 15 or 20 articles a week for an extra hundred bucks or so each week. That’ll help. If you’d like me too, I can write a post or a tutorial on earning some extra cash that way. Just let me know.

Step 6:
Before we fully commit to paying down the debt we need to have a small amount of savings just in case. I like to save a thousand dollars and just put it in a bank savings account. The idea here is not to get derailed if you have a small emergency come up. $1,000 will often take care of those small emergencies.

If a small emergency does come up and you have to pay 500 bucks to replace the fridge or something, then stop the debt snowball (Step 7) until you’ve rebuilt your emergency savings back up to 1 grand.

Step 7:
Attack the debt with the debt snowball approach. There are a variety of ways to pay down debt using the debt snowball. The way I prefer is to pay down the biggest interest debt first. This approach will save you hundreds and perhaps thousands of dollars in interest fees and payments over the time it takes you to pay off your debt.

However, sometimes it might take several months to pay off that first debt with the highest interest rate. If you have a credit card with a 20% interest rate that is your highest interest bearing debt and you owe $10,000 on it, if you only have an extra $200 for your debt snowball each month then it could take you a long time to pay off.

On the other hand, if you choose to pay off your smallest debt first which say is a line of credit debt with an interest rate of 10% but you only owe $1,000 on it, you could pay it off sooner and get energized by smaller but earlier wins.

So determine how you best like to be motivated. If you like to attack bigger debt with bigger interest first go for it. If you think your enthusiasm will flag if you have to wait months and months before you get rid of any debt then pay off the smaller debts first. But whichever system you choose stick with it.

Both debt snowball systems work the same way. You’ll pay the minimum amount on all debts that you need to, and then you’ll put every last penny of extra money against your debt snowball approach. So for me, I’d put the $200 on my highest interest based debt.

Each month you follow the same approach to paying down your debt. And when the first debt is eradicated you go to the second one. So in my case, after my highest interest debt is paid off I attack the second highest interest debt. So I’m paying the minimum on all my debts, plus I then put the $200 on this next highest debt, plus I add the minimum payment to this debt which I was paying to my original highest debt which no longer exists. This is how the debt snowball snowballs. As you pay off each debt you add that debts minimum payment which is no longer needed to the next debt that you’re know focusing on.

Let me highlight an example:

Debt A 20% minimum payment $50.
Debt B 18% minimum payment $55.
Debt C 15% minimum payment $40.

I’m paying the minimum amount on all debts each month which is $145 (50+55+40). I have an extra $200 each month left over after I’ve paid all my living expenses so I add that to Debt A. When I’ve finished paying off Debt A, my minimum monthly payments are now only $95 (55+40) because I no longer have Debt A. So I now add that extra monthly $200 to Debt B plus I also put Debt A’s no longer needed minimum payment of $50 onto Debt B. Hope that makes sense.

Step 8:
Become a master at faster debt repayment. This is where you can get your PhD at paying down debt super fast. Keep seeing how you can trim expenses and or increase your income. An extra $200 a month in my example will help you pay down your debt, but in order to get to living debt free fast, find ways of earning an extra $500 a month. Now you have $700 a month to attack debt and you’ll easily become debt free in 5 years. Hell, folks have become debt free in less than 2 years by being diligent, focused and aware.

And the funny thing is, as you become more financially responsible you’ll find that money starts coming into your life. You might get a raise at work or a small rebate of some kind. It seems that money is attracted to responsible financial stewards.

Step 9:
Reward yourself. At the end of the road, when you’ve finished paying off all your debt (except for mortgage at this stage) whether that takes you 1 year to get out of debt or 2, 3 or even 5 years to become debt free, reward yourself.

By that stage, you’ll likely be spending a thousand or so dollars on paying down that last bitter bite of debt. When the last of your debt is gone, celebrate. Take a vacation, have a nice meal. You’ve done it and you deserve to be rewarded. But don’t get into debt to do it!

Step 10:
Never a borrower be. Continue to pay down the last of your debt which at this stage should be nothing more than mortgage. Pay that off faster but never again become ensnared by the shackles of debt. Promise yourself to be debt free for the rest of your life. You can do it. We don’t need debt as much as we might think we do.

Save up to buy a car or a house. Perhaps a mortgage might be okay as the only debt, but I’d still prefer to see folks debt free across the board and without mortgages. It was good enough for our grandparents and it can be good enough for us. We don’t need to have everything anytime we want it. In fact most things if you’ll just take a small moment to think and meditate upon we don’t actually need. Our real needs are very few and don’t require us to get into debt for.

I hope you’ve enjoyed these 10 steps on how to become debt free. Whether you become debt free in fiver years or 5 months, with determination and a committed sense of purpose you can experience the joys of living debt free for the rest of your life.