7 Steps to Eliminate Debt
Debt can be a terrifying experience for some. This is a basic guide to help you work through your debt issues and start to leave them behind
Don't Panic, Stay Calm, Get Started!
Debt can create a great deal of stress and lead to high anxiety, even panic. STOP! It is really important that you remain calm. In fact you need to get really cold hearted and realistic about things. You need to observe your situation in a dispassionate light and try to remain as detached as possible. This way you will not only stop yourself damaging your health, you will also be far more effective at dealing with your financial crisis.
Think of the whole experience with a new perspective, this is your OPPORTUNITY to really get to grips with your finances, turn things around and start out toward the WEALTH that we all naturally deserve. YOU CAN DO IT! YOU CAN BE DEBT FREE! Many people have come out of their debt situations much wiser about money and moved on to become very wealthy, you can too!
If you are unable to control your emotions or face dealing with your financial situation, it sometimes helps to talk things through with a trusted friend or colleague but if this is not an option there is a list of places that you can turn to for help here. But remember, there really is NO SUBSTITUTE for taking responsibility for your own position and to really emerge from debt with a new perspective, you have to get stuck in and start cleaning up your own mess!
The hardest part of any journey is the first step. Take it now. Simply doing Step One will often be sufficient to psychologically break the back of the problem. Just getting to grips with the paperwork is the one thing that puts many people off dealing with their debts, once they set to it, things begin to flow.
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Step One - Collect Details of Debt, Income & Expenditure
Before you can deal with your debt problem, you need to know exactly where you are financially. You will need to collect together all your financial documents including the following:
- Income Statements
- Credit Card / Shop Card Statements
- Bank Statements
- Current Debt documentation
- Utility Bills
I recommend getting all your financial papers well organised up front, use a small mobile filing case or similar. File each debt and each category of income and expenditure in a separate file. This way you will always have the document you need to hand.
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Step Two - Determine Income and Expenditure
Before being able to effectively deal with debts, we need to know what is going in and what is going out. This information needs to be accurate, so this requires that you be brutally honest with yourself and your figures. Use our Income and Expenditure calculator to create a worksheet and to help you determine your current financial position.
No matter where you turn for advice or help or any progam you may use to help you out of your debt; You will need to do this step. It is absolutely imperative that you do it yourself. It is vitally important for the process that you become intimately knowledgeable about your own finances because nobody else will ever care about them as much as you do and it will ultimately always be you who has to make the key financial decisions based on your financial decision. This is not a job for a stranger or some other disinterested 3rd party.
You should sum up each income and expenditure category over the period of at least a year and then divide by 12 to get the monthly figure. Leave nothing out, use your bank statements, check books and bills to work out an accurate average monthly figure.
I can assure you that if you mange to complete this stage successfully and honestly you will already be feeling much better and will already being feeling more in control. You will also almost certainly already spotted some things that you could do to actively improve the situation.
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Step Three - Prioritizing Your Debts
List out all your debts ( you should already have this as part of the previous step).
If you have received any court papers or letters that seem urgent, you must deal with these as a matter of priority. Remember it is ALWAYS better to deal with financial debt BEFORE it reaches court. If the debt is genuine, YOU could potentially end up paying additional legal fees, lawyer fees as well as severely damaging your credit-worthiness. That can have knock on effects on any other credit you may have. Your creditors simply want to get paid, they don't want legal hassle either, once debts reach this stage a creditor often only end up with a fraction of the original debt. See Talking and Negotiating with Creditors.
If you are not sure from the documents you received what you should do next, get advice straight away from an experienced adviser.
Once you've made a list of all your debts, you need to work out which creditors you will need to deal with first. There are some debts that have to be prioritized because failure to deal with them could have far more serious consequences than with others.
High Priority Debts
High Priority Debts are those debts that you simply must pay or there will be severe consequences. These consequences vary from country to country but generally the following can be considered priority debts -
- Mortgage or Rent arrears can lead to you losing your home
- Utility and Energy bills can lead to you being disconnected.
- Child Care Can put your children into poverty
- Taxes & Governments hate not being paid and usually have a very nasty sting!
All other debts need to be prioritized according to the potential consequences and your particular circumstance. For example, if you absolutely relied on your car to get you to work, having that re-possessed would be a disaster and would need to be prioritized high on your list.
If you have credit card debt - prioritize them in order of interest rate, with the cards with the highest interest prioritized highest. In general this is a good way to prioritize debts, it always makes sense to try to pay off the most expensive debt first.
By the end of this step you should have all your debts prioritized in a list with the basic details of the debt for each item.
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Step Four - Create your Budget
Take the Income and Expenditure Sheet you created using the Income and Expenditure Calculator in Step Two. You now need to review both your income and expenditure and see if you can improve things.
Your hard copy of your original Income and Expenditure worksheet will show you what your current shortfall is. If there is no shortfall then you are in a great position to start paying down your debts immediately.
If however your expenditure is greater than your income you are going to have to find the money to help pay down your debts, this can only be achieved in 3 ways:
- Reducing Your Expenditure
- Increasing Your Income
- Reducing Your Debts or debt payments (see next section)
Examine all the practicable options, make any calls you need to make (remember to get anything said on the phone confirmed in writing ** very important **). At the end of this process you may have found sufficient leeway to start paying down your debts effectively.
Enter your new budget figures into the Income and Expenditure Calculator and print off a copy. This is your budget. Every Debt program ever created, if you go to any Debt support agency, they will ALL require you to get to this point. The truth is that once you are here, things get much simpler because AT LAST we know what we are dealing with, the FEAR is gone!
Reducing Your Expenditure
This is often referred to as 'trimming' expenditure. When you were creating you Income & Expenditure Worksheet you almost certainly spotted areas where savings could be made. The more drastic your circumstance the harder you are going to have to prune back. A word of warning here; always set realistic goals, unachievable and unrealistic goals are dishonest and will not serve you. Always prefer to cut back on the non-essential expenditures first, you may be pleasantly surprised at how substantial the savings you can make are!
Look for habits that you can give up, smoking,drinking etc. Savings can be huge. Try to see if you can do things differently and make savings.
Enter your new revised expenditures into the Income & Expenditure Calculator.
See "Debt Busting - Reducing Expenditure for more Expenditure reduction tips".
People often believe that they can do very little about their income. This is simply wrong, there is ALWAYS something that can be done. It may require some thinking 'Outside The Box' but often the results are very positive and sometimes life changing.
Things to consider are
- Entitlements to some form of government support
- Seek a pay rise or a better job
- Seek Education for a better Job
- Consider an additional job
- Consider other possible streams of income
If you have a partner or family, everyone should consider how they might contribute. For further details of potential new income streams see Wealth Creation & Increasing Income.
This is an important area to consider, but DO NOT enter any potential increase in income until you have either realized it or it can be relied upon to happen.
Complete You Budget
Print out your new budget from the Income & Expenditure Calculator. This represents what you think you are able to do as things stand. This budget will change as you are able to implement some of the other strategies outlined in the next sections.
You can use the Income & Expenditure Calculator to generate new budget scenarios based on other possibilities until you are able to produce a budget that suits you and offers a clear path out of debt.
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Step 5 - Review Debt Strategies
At this point we have an initial budget and you will know whether you have sufficient funds to meet your financial obligations. If you do, that is great and will provide some relief; but in either case there is other essential things to consider before completing your budget.
It is worth taking some time to consider the best strategies for reducing your debts. Typically they will include one or more of the following.
- Reducing Spending (Budgeting)
- Increasing Income
- Reducing Debts & Debt Payments
- Consolidation Loan
- Negotiating With Creditors
- Bankruptcy & other Legal Alternatives
These 6 options are the primary areas that need to be considered, each can actively improve your financial position and if acted upon could make a substantial difference to your income.
When you have reviewed all your options and decided on which is the best combination of strategies for you. Re-work Your budget to include the potential benefits of each strategy just to make sure all the figures work.
This has already been covered briefly under Create Your Budget and is covered more extensively "Budgeting and saving money tips.
This has also been covered briefly in - Create Your Budget and there are more ideas and suggestions for increasing income here.
Reducing Debts & Debt Payments
Clearly one of the best ways to get your debts back under control is to reduce them! If you have anything that you no longer need that you can sell, you should do so and use the money to reduce your debts. Often just the sale of one asset is enough to bring a dire situation back under control.
So the first thing to do is to make a list of all the major assets you are prepared to sell. This is one of those moments when you must make a FUNDAMENTAL CHOICE between THINGS and your own FINACNIAL FREEDOM. Do the right thing! If you have an asset that is not helping you towards one of your key life goals, SELL IT!
The important thing is once you have identified something to sell, is to get on with it immediately and as soon as it has been sold, put the money towards bringing your priority debts and payments back into order and paying down your most expensive debt.
Debt Reduction Ideas
If it your mortgage is costing too much you may need to consider refinancing to a better deal or down-sizing. Always cost in the expenses involved in such a choice.
If you have more cars than you really need or you can down size one, you may be able to eliminate or reduce an auto payment.
If your home is full of clutter why not have a household sale or start selling off all that STUFF you have that you never use on eBAY. Using eBay is easy and you can sell virtually ANYTHING, even half used things. You can sign up for eBay here and get started right away, who knows you could end up running your own eBay online business!
The great thing about selling things to reduce your debt is not only can you make a major impact against the amount of money you owe, you also get to de-clutter your life and that in itself can be a cathartic experience.
Reducing Debt Payments
Another important approach to bringing debts under control is to reduce the regular monthly payments that need to be made. For example you may be able to reduce your monthly mortgage payment by switching to "interest only" for awhile, if your provider will permit it. You may also be able to refinance some loans over a longer period or consolidate several of your more expensive borrowings into a lower cost consolidation loan. (see also Consolidation loans and their dangers)
Credit Card companies will often reduce interest rates if they can see that you are serious about your repayment plans and prove to be reliable in delivering on your promises.
A Consolidation loan is a loan that is used to repay a number of smaller debts and consolidate them into one loan. Generally this is a good strategy if you are able to obtain a consolidation loan on good terms and you are certain that you will be able to maintain the repayments over the long term.
These loans often require that you use your home as collateral. This means that you may lose your home if you do not keep up the payments on the new loan. However the upside is that you may be able to substantially reduce your debt payments to a level that you can more easily afford.
An additional benefit is that you have reduced the number of creditors. This can be a huge relief if you have been under pressure to repay from several creditors at once.
There are some very important considerations in relation to consolidation loans. Perhaps the most important is DO NOT JUST LOOK AT THE REPAYMENT AFFORDABILITY. It is imperative to ensure that you obtain a loan on the very best APR and terms that is possible. It is often fairly easy to obtain loans on truly appalling terms that APPEAR to be highly affordable. So beware and read the small print The points you need to be sure of are
- Good APR
- No penalty for early repayment (unscrupulous lenders use this to 'lock' people into bad deals.
- Ask for a detailed and WRITTEN statement of ALL potential charges.
- Be sure that this NOT a NEGATIVE AMORTIZATION loan, where you may end up owing more than you originally borrowed.
- YOU have read ALL the small print!
- Don't borrow more than you need
You have already established a budget and at this point it may be sufficient on it's own to deal with the situation, You should also be actively pursuing the possibilities of increasing your income which you can integrate into your budget when they come to fruition.
Negotiating with Creditors
It may be possible to persuade creditors to 'write off' the debt or to reduce it substantially, especially if you can demonstrate some form of hardship such as genuine poverty, illness or old-age. They will certainly want proof before considering such a move. Generally however they will be reluctant to forgive a debt that is properly due unless your position is so untenable that you are considering bankruptcy in which case it is very much in their interests to reach an agreement with you;
Only use bankruptcy as a threat if it is an active possibility for you. Remember, they know more about you and your financial position than you might think. They are likely to ALREADY KNOW whether bankruptcy is a plausible option for you. If you lie to them, they will likely know it and you will have shown that you cannot be trusted to deal honestly. Make a point of dealing honestly with everyone when you do strike a deal, stick to the agreements you make.
If you are unable to plead some of the above exceptional cases, it may be counter-productive to seek a 'write-off' or debt reduction from creditors and might simply cause them to become anxious if they are not already aware of your financial predicament. Generally it may be better to try to negotiate lower repayment terms. For example lower interest rates from credit cards ( be prepared to switch if not), repayment holidays on your mortgage if possible (ie interest only for awhile).
Do not enter into negotiations with your creditors until you have decided on your EXACT strategy. It is important that when you agree an arrangement with your creditors, you know for certain that you can afford to keep your side of the deal.
What you should ask creditors for will vary depending on:
- the level of debts you have
- the amount of money you have available to offer
- the amount of assets that you have to sell to pay off some or all of the debt
- if your situation is likely to improve.
Ensure that what you are asking from your creditors is reasonable. Make sure you:
- are clear about what you are asking for
- ask to freeze interest. It is important to freeze interest, otherwise the debt will continue growing. Even if you are still making regular payments
- provide documents and evidence to support your request to the creditors.
- inform creditors of any changes in your circumstances that will affect your ability to meet the terms of your agreement.
- contact creditors as often as necessary to get agreement.
Always keep copies of correspondence to creditors and also keep notes on any phone calls you have with them. This can be useful later if you need to recal facts or dates.
Don't be tempted to offer more than you have if creditors are difficult. If you can't get the creditors to agree after a few tries, get help from an adviser.
If you make a deal with a creditor, follow up in writing what was agreed and get them to confirm it in writing. Give as little information as possible over the phone, just stick to the subject and go for an agreement.
Bankruptcy & other Legal Alternatives
Bankruptcy is usually a debt management option of last resort as it has long term and far reaching effects. If you have completed your budget sheet and looked at the other potential strategies above and non are sufficient to "close the circle", then your financial circumstances are very serious.
If you are going to consider this option, you must get proper advice before making any decisions.
For the US Chapter 13 & Chapter 7 Bankruptcy's are covered briefly here. UK Bankruptcy and other options are covered here.
If bankruptcy is a real consideration then it is worth making negotiation with your creditors part of your strategy. They may well be prepared to consider writing off a substantial part of your debt and offer favourable repayment terms of the rest if it means that you don't go bankrupt. If you do, they may get nothing. If you enter into such negotiations, be sure to do what you can to protect your credit, make not receiving any negative credit entries part of the negotiations and get any agreement in writing.
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Step Six - Implementing YOUR debt plan
Finalizing a Strategy
At this point you need to make a clear choice about which strategy you are going to employ.
Here are two potential strategies that could be adopted.
Equity Available, Sufficient Income
- Develop Your Budget - Up income- Reduce Spending - Know what you can afford.
- Negotiate repayment terms and protect your credit.
- Consolidate all your debts into one loan on a GOOD APR.
- Pay down consolidation loan with ALL spare cash
For most people, this is a very effective strategy, especially if you have some equity or collateral to help support your position when obtaining a Consolidation Loan. The benefits are that it is simple, involves only minimal negotiations with creditors and can resolve the problems relatively quickly. The important thing here is that when you negotiate satisfaction of the debt, you negotiate any negative credit entries away and get you agreement in writing.
The importance of this is that if you can improve your credit rating. As you have repaid your debts, had some of the negatives removed from your credit report and are now making payments reliably you should expect an improvement in your credit rating and use this to get better terms on your remaining loans.
No Assets Insufficient Income
If you have no equity and very few assets and your income is still insufficient to meet your debt obligations, then a different strategy will be needed. In a bizzare way you are actually in a very strong position. YOU have NOTHING TO LOSE, your creditors will be the losers if they force you to the wall. This puts you in a very strong negotiating position.
This Strategy will involve negotiating down your debts with your creditors to a level that you can afford them or getting them written-off. This should be possible if you can show genuine hardship or ill health. In this strategy you use the threat of bankruptcy (where they may get nothing) to negotiate HARD. The truth is that if you cannot agree terms with your creditors, bankruptcy may be a serious consideration.
- Develop Your Budget and Know what you can afford.
- Seek expert advice, this can often be obtained free.
- Negotiate Debts down HARD or get them written off. To the point where you can afford the repayments. Agree favourable repayment terms if you are unable to consolidate. Always try to protect your credit during these negotiations. ALWAYS AGREE THINGS IN WRITING.
- Consolidate the debts into a consolidation loan if you are able to obtain one on good terms.
- Stick to the budget and use all spare cash to reduce debts.
Complete Your Budget
Try to get your budget sorted out BEFORE you speak to any creditors. It is far better to be able to speak to them with a clear plan of action in mind.
Agree Consolidation Loan
If you are seeking a consolidation loan, get the terms agreed as early as possible.
Write Out Your Plan
Write your strategy out. Print off your final budget.
Decide Which Creditors to Approach
Choose which creditors to approach and what you are going to ask of them. Keep it honest and reasonable.
Seek advice from an experienced advisor if you are unsure about anything. It is always best to be completely certain about what you are doing.
Call up your creditors and agree either repayment of the debt or agree an arrangement you have budgeted for.
If you have arranged a consolidation loan, do not pay off any of the creditors who have not confirmed your agreements in writing. Wait for them to do so before repaying.
Follow through on all the changes you committed to as part of your budget. Failure to do so is likely to lead to you falling back into debt.
Keep a regular record of your spending and every week confirm that it is consistent with your budget.
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Step 7 - Eliminate Debt Forever
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Other Debt Alternatives
Debt management plans (DMP)
If your financial problems stem from too much debt or your inability to repay your debts, there may be some benefits in enrolling in a debt management plan (DMP). You should only sign up for one of these plans after taking proper financial advice and having spent time thoroughly reviewing your financial situation, and receiving personal advice on managing your money. Even if a DMP is appropriate for you, a reputable credit counseling organization still can help you create a budget and teach you money management skills.
In a DMP, you deposit money each month with the DMP organization, which uses your deposits to pay your unsecured debts, like your credit card bills, student loans, and medical bills, according to a payment schedule the counselor develops with you and your creditors. A DMP will require you to make regular payments and could take as long as 48 months or more to complete.
The advantages of using a DMP are that:
- you make only one payment direct to the DMP organization. They divide the payment fairly between all your creditors
- you don't have to contact your creditors yourself, they will do this for you.
However there are also disadvantages to using a DMC:
- most DMCs charge an upfront fee which can be quite high. This leaves you with less money to pay off your debts
- most DMCs also charge an administration fee to the customer each month. This leaves you with less money to pay off your debts
If you do use a DMP, check the agreement carefully before signing anything. Check:
- whether you can cancel at any time if you are not happy with the service
- what the fees are
- whether you will get your fee back if you cancel
- which creditors the DMC will deal with and which creditors you still need to deal with.
Bankruptcy In The United States
Bankruptcy laws vary widely through out the world and is usually the very last option for debt management because although an individual may relieve himself of much of the debt he was previously burdened with, there is often some stigma attached to the process and there can be problems obtaining credit for many years afterwards.
Broadly speaking these laws are designed to give an opportunity for the individual who has got themselves into a position where they can no longer meet their debt payments to go through a legal process and come out the other side free of virtually all previous debt and be able to start again with a clean slate. However they may well emerge on the other side with little or nothing in the way of assets.
Chapter 13 Bankruptcy permits individuals with a steady income to keep property, things such as mortgaged house or a car, that they might otherwise lose through the bankruptcy process. In Chapter 13, the court approves a repayment plan that allows you to use your future income to pay off your debts during a three-to-five-year period, rather than surrender any property. Property is only protected if the repayment proposal includes catching up with unpaid mortgage payments and security liens. After you have made all the payments under the plan, you receive a discharge of your debts.
Chapter 7 Banckruptcy is known as straight bankruptcy, and involves liquidation of all assets that are not exempt. Exempt property may include automobiles, work-related tools, and basic household furnishings. Some of your property may be sold by a court-appointed official 'a trustee' or turned over to your creditors.
Both types of bankruptcy can get rid of unsecured debts and stop foreclosures, repossessions, garnishments, utility cut off's and debt collection activities. They also provide some exemptions that allow individuals to keep certain assets, these vary from state to state.
Personal bankruptcy does not usually remove obligations for child support, alimony, fines, taxes, and some student loans.
Bankruptcy & Legal Protections in the United Kingdom
This is very similar to the Chapter 13 Bankruptcy in the US. If an individual is unable to meet his debt obligations he can apply to the courts for a Bankruptcy Order. Like in the US he may be able to keep certain personal goods. Bankruptcy can last as little as one year, after which most debts are written off (except court fines & student loans). The process involves liquidating all major assets and usually leaves the individual with very little in the way of assets.
If an individuals were considered to have behaved recklessly and taken goods or money knowing that it could not be repaid a 'bankruptcy restriction order' could be made out against them. Such an order can last for 15 years and can make an individuals financial affairs very restricted.
You can apply for an Administration Order if your total debts are less than £5,000 and you have a county court judgment (CCJ) against you. The court decides what is a fair amount depending on your income. The court can agree that you only pay part of the total debt. This is called a "composition order".
Once the order is agreed by the court, you make one regular payment to the court and your creditors can't take any further action to get the money back, as long as you keep to the payments.
Individual Voluntary Arrangements (IVAs)
An IVA is a negotiated legal agreement with creditors to repay your outstanding debts, either in part or in full. The arrangement is monitored by an independent Insolvency Practitioner (normally a solicitor or an accountant. 75% of creditors must agree to an IVA.
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Debt and Your Credit Report
You need to be aware that some of the options to deal with your debts will affect your credit record. This will mean that it will be more difficult for you to get credit in the future, including a mortgage or even getting a new mobile phone contract.
This is because information about your financial situation is collected and stored on file by credit reference agencies. They give this information to lenders like banks, building societies, finance houses and major retailers. The lender uses this information to help them decide whether or not to give you credit.
It is important that if you intend to repay a debt that you negotiate the removal of any negative entries in your credit report. Given the choice of getting paid or deleting the negative entry, most will go for the money. This is particularly true of Collection Agencies.
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Further Debt Help
If you find yourself with debt problems there are usually several places where you can go and get free
help. These are listed here under Free Debt Help.
It is essential that if your debts start to overwhelm you or you feel unable to deal with your debts that you seek proper expert advice. Often these experts are free and they will be able to provide sufficient guidance to help you resolve your
issues without further intervention or provide advice on where to go if you need more substantial assistance.
Always check up-front that you consultation is free. If any debt management plan is proposed, be certain that it is right for you, know the costs and speak to an independant advisor first.
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