Sunday, February 10th, 2008...9:21 pm

Getting out of debt, Part I

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A young reader asks:

“Can you write more about how you got out of credit card debt?”

The most important principle that I recommend is to take to heart the point embodied in the following quote:

“Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.”
Charles Dickens (1812 – 1870), David Copperfield, 1849

Countless studies have been conducted over the years that indicate money does not buy happiness. What does buy happiness is learning to live on the money that you make — or better yet, a little bit less than the money you make. Far too many people spend more than they earn, and when they get more money, they spend more than that too. These people continually raise their standard of living as they get more money.

I have come to believe that the only way to be truly happy with my financial situation is to live on less than I earn, and when my income rises I do not allow my spending to increase proportionally. It pains me to see friends, family, coworkers, etc. forever believing that if only they had a little more money they would be happy. These people get raises, win the lottery, and come into more money in any number of ways and are happy for a short period of time, but inevitably become unhappy again and fall back into money problems, not necessarily in that order.

With all that being said, please accept the first part of my advice for getting out of debt:

1. Stop contributing to the problem.

  • Remove all your credit cards from your wallet. Carry one if you must — but use it only for emergencies.
  • Make all your purchases in cash. If you don’t have the cash, you can’t afford to buy it.
  • Call your credit card issuers and tell them to stop sending you “convenience” (as in — “Look how convenient it is to get further into debt!) checks.
  • Consider the influences that have caused you to overspend in the past. Keeping up with the Joneses? Move to a new neighborhood, figuratively or literally. The only person with whom you should be competing is yourself.

If that’s not enough:

  • Put the card you have had the longest in a plastic container. Fill the container with water, cover, and place in the freezer.
  • Cut up all the rest of your credit cards.
  • Call the 3 credit bureaus and have them put freezes or holds on your credit reports. This will keep you from getting instant credit (and a free bag of M&M’s if you’re lucky) at Macy’s.

2. Reduce the overall interest rate on your debt.

  • Roll all of your debt onto one card with a low interest rate, even if it is a short term rate for now. Don’t roll any debt that is at an already lower rate.
  • Take out a personal loan at a relatively low, fixed rate. Consider working with a financial institution with which you already do business, such as your student loan servicer.

If that’s not enough:

  • Take a loan against your 401(k) balance if possible.
  • Borrow money from family and friends

3. Maximize the amount that you can contribute to reducing debt.

  • Develop a spending plan that focuses on needs and eliminates most wants. Leave yourself some pleasures, however, or the spending plan won’t work for long. If you are married or have a very significant other, make sure to involve him or her in the process. It will be difficult to maintain a spending plan if partners do not agree on it, or if one partner has no “buy in” on the plan. There should be many ways to generate some extra cash to put towards your debt: eliminate or scale down your cable TV plan, drop any extra services on your phone plan, turn your thermostat down, cook more and eat out less, make your own lunch, quit smoking, switch your gym membership to a pay-as-you-go plan — you probably don’t go as often as you should anyway, so why pay for it? Most people are surprised quickly by how much extra money they can free up once they see and understand where all their money goes. They don’t realize how easy it is to fritter away hundreds of dollars a month on stuff that ultimately does not improve, and in some cases actually detracts from, the quality of their lives.
  • Earn extra income. Ask your boss for a raise. If she says, “No,” ask her what you can do to earn one. Get a second job. Use the proceeds from it exclusively for paying off debt.
  • Downscale your lifestyle, Part I: Sell your car and buy a used Honda Accord. They’re cheap, reliable, and sip fuel instead of guzzling it. Move into a smaller apartment. Sell your Wii and PS3.

If that’s not enough:

  • Downscale your lifestyle, Part II: Temporarily move in with friends who’ll charge you little or no rent. Sell your car and use public transportation. Sell your TV and stereo and get a library card.
  • Sell your house and buy a smaller one — or start renting again. You might find that the monthly payments are less than your mortgage, insurance, and taxes. Use the equity from your home to pay off your debts and then start saving a new down payment.
  • Declare bankruptcy. I hope very few of you ever come to this point.

In my next article on this subject, I’ll lay out what the best way to attack your debt is now that you’ve taken the first and most important steps.

See also: Getting Out of Debt, Part II and Part III