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Becoming Debt-Free: Your Options

Becoming debt-free may seem unattainable, but there are several options for getting out of crippling debt or minimizing the pain.

There is no one-size-fits-all approach to personal finance. You have self-help and legal options to fit your own unique situation and needs. In this article, we discuss:

  1. How to deal with the debt you have, including how to develop a budget and how to work with creditors
  2. How to avoid more debt

How to Deal With the Debt You Have

Creating a money management plan that works for your debt and spending habits is the first step in taking control of your finances. If you have already worked out a budget and believe paying down debt is impossible, then you may want to consider working with your creditors or finding debt relief through bankruptcy.

Developing a First-Time Budget

A budget is a guideline for how much money you can realistically spend based on your income and assets. The goal is to stop you from overspending, avoid new debt from unexpected expenses, and start your debt repayment.

To get started, list your:

  • Total take-home income (after taxes)
  • Fixed monthly expenses (such as rent, car loan, cell phone, car insurance, and health insurance premiums)
  • Necessary costs that vary from month to month (such as clothing, gas/transportation, and food)

With this information, you can identify necessary expenses.

Once your day-to-day necessities are covered, you can focus on paying down loans or making debt payments with the money left over.

If any extra money is left after making debt or loan payments, you can prioritize the rest or choose to save money. This is the basics of creating a simple budget.

While creating a budget is a major undertaking in itself, sticking to a budget is another matter altogether. The key is to be objective in your analysis of how you spend money and be realistic in creating a budget you can stick to.

Tips for Totaling Your Full Income

Take stock of every source of income that you have. If you have a regular paycheck, tally up your monthly take-home pay. If you are self-employed, be sure to include any income you generate and any outside income sources.

A few examples of extra income include:

  • Dividends from stock
  • Interest
  • Commissions
  • Bonuses
  • Pensions and Social Security
  • Alimony or palimony payments
  • Child support payments

If the income is not regular, note the average of that income over 12 months. The goal here is to come up with an average monthly income.

Tips For Gathering Your Bills and Expenses

After you've taken stock of your income, you'll have to spend a significant amount of time and energy on tracking your expenses. You should begin by tracking regular costs such as mortgage payments, student loans, utilities, car payments, insurance, child support, and any other obligation you pay each month.

These are considered fixed payments and most likely will not change much over the long term.

The next step is to track your variable expenses for about two months. Variable costs include groceries, dry cleaning, entertainment, dining, clothing, gasoline, and similar items. If you withdraw money from an ATM, note it, and then be sure to write down exactly where you spend that cash.

You can do a shorter period if you prefer. However, you'll want to track your expenses for a longer time to better understand how unexpected or irregular expenses affect your budget.

Changing Your Budget

After you've tallied up your total income and total costs, you will immediately see if your expenses are more than your monthly income. You can begin to make decisions on where to cut down spending.

Your budget isn't a final document—you'll want to make changes as new expenses come up or around the holidays.

You should project the budget for the next year and then compare your projections to the actual income and expenses.

Examples of major budget categories that can change over time include:

  • Home
  • Entertainment
  • Food
  • Healthcare
  • Transportation
  • Insurance
  • Clothing
  • Gifts
  • Pet care
  • Taxes
  • Education
  • Personal business expenses

Within these major headings, you'll have sub-headings and sub-categories. For example, under "home" you'll include home-related expenses such as utilities, cable, rent, cleaning supplies, etc. Don't forget that bills might change with the seasons. This is not an exhaustive list. You should modify, add, or delete categories so that they better reflect your circumstances.

The obvious goal here is to make sure that your income is higher than your expenses. But what a budget does is allow you to see exactly where your money is going so that you can make adjustments and cut down on unnecessary costs. You'll also know whether you can afford a particular purchase or how much you'll need to save (and where you can cut down) to buy it.

Try not to get frustrated if you do not immediately comply with your budget. In all likelihood, you have forgotten some regular expenses. Use your budget as a guide. If you overspend in the same category every month, you probably need to change the projected amount for that category.

The amount of difference you want between your income and expenses is a personal choice, but financial experts say you should save at least 10% of your income, so you have a healthy cushion in the event of financial trouble. This emergency fund is helpful to stay debt free in the future.

Sticking to a Monthly Budget

Making your budget is time-consuming, and you may feel as though you're done once it is complete. But you still have to remain faithful to your budget, or your effort will be for nothing. Think of your budget like a diet. You want to stay on it, but if you splurge on one day or in one area, it's alright; you'll just have to make up for it in another area.

Your budget is simply a guideline for your fiscal behavior. Go too far off the path, and you'll be in the financial weeds. A budget should give you a sense of where you are financially and what you can afford. Just remember how much time you spent calculating the budget and how objective you were when you created it. Trust yourself—that you knew what you were doing when you made the budget—and you'll be better off for it.

Dealing With Debt: Contacting Your Creditors Directly

Many people find that budgeting alone isn't enough to work down their debt. It is in your best interest to contact creditors directly when you're unable to make payments and work out a modified payment plan.

Creditors do not want you to default since they would rather collect monthly payments from you. You may be able to work out an agreement by contacting your lender immediately if you fall behind on a payment.

Once your account is in collections, it is too late to negotiate with creditors. It is essential to know your rights when debt collectors call you.

Credit Counseling and Debt Management Plans

There are services to help you get out of debt, but you need to make sure the company is not a scam. These options are available to you:

  • Credit counseling to create a budget and handle long term financial concerns
  • Debt management plans (DMP) allow you to deposit a certain amount of money with a credit counseling organization each month. This is used to pay credit card bills, student loans, and other unsecured debts.
  • Debt consolidation rolls multiple debts into one to lower your overall interest payments
  • Debt negotiation programs (DNPs) help you negotiate payments to creditors that are only 10% to 50% percent of the original balance owed. But be aware: these services often have hidden fees that keep you in debt.

Debt Relief Through Bankruptcy

Personal bankruptcy is often considered a last resort if other methods of debt relief have been exhausted (other than DNPs, which should be avoided in most cases). But bankruptcy is an effective solution for those who are unable to pay off debts.

The two main types of personal bankruptcy are Chapter 13 and Chapter 7. By filing for Chapter 13, you may be able to keep your assets and property while making regular payments under a bankruptcy plan. Chapter 7 may result in the liquidation (sale) of some of your non-exempt assets (property) to pay off creditors in exchange for completely removing most of your debt.

How to Avoid More Debt

Avoiding debt altogether would be the surest method to ensure a secure financial future. Credit card debt tends to be the most treacherous kind of debt most consumers will manage.

Some considerations about how credit card debt can help problems from developing:

  • DON'T charge what you can't afford
  • DON'T charge food purchases
  • DON'T take cash advances
  • DON'T purchase special services
  • DO create a budget
  • DO use only for emergencies
  • DO pay the balance in full each month
  • DO pay on time
  • DO limit the number of credit cards
  • DO read the fine print
  • DO keep a record of purchases
  • DO leave your credit cards at home

Prioritizing Your Financial Goals

In the future, you can make and prioritize your financial goals. Saving a down payment for a new home may be more important to you right now than maximizing your 401(k) contribution. Because you only have limited resources, you will have to allocate them according to your priorities.

Creating a Spending Plan for Holidays

Target the people to whom you'll be giving gifts. Create an honest budget and distribute that money according to your wishes.

During the holidays, your budget will likely go over by a certain amount. But if you have your budget and how much you've already spent, you are less likely to splurge on gifts.

Get Legal Help to Avoid Debts

Becoming debt-free can be quite liberating, but make sure you explore all of your options and choose wisely.

If you fall into debts that you're unable to pay back, consulting with a skilled bankruptcy attorney can be very beneficial. An attorney can help you sort through your debts and explain your options based on your specific circumstances.

Next Steps

Contact a qualified debt and bankruptcy attorney to find out your options for navigating the best path forward.

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