Monday, April 19, 2010

You Owe It to Yourself to Get Out of Debt

Wouldn’t you like to get out of debt? Just think of how good you’d feel, and how much money you’d be able to save, if you didn’t have to make payments each month for things you bought in the past. Maybe you’re reading this and thinking about your grown daughter or son with a young family. Wouldn’t their lives be better if they could get free of the heavy weight of debt? The good news is that for almost everybody, it’s not only possible—you owe it to yourself to do it.

Carrying debt is very stressful, yet Americans have a lot of it. Many middle and upper income families never get free of consumer debt, student loans, and car payments. They just keep paying and paying (very profitable for the banks and finance companies), and then adding on new debt. Reminds me of that old coal mining song: “St. Peter don’t you call me, ‘cause I can’t go—I owe my soul to the company store.” Even investors can have unnecessary debt. They get caught up in the trap of thinking that if they can make more in risky stock market returns than the interest they are paying on their loans and cards, they’re beating the system.

In my experience in counseling families over the years, I’ve found that there are four important reasons for reducing and eliminating debt:

1. You’ll be more likely to survive financially if something bad happens in your life—loss of a job or a forced early retirement, a serious illness of a family member, or something else.

2. Most interest charges are not tax deductible. Suppose you are in a 25% tax bracket. In order to pay $100 in interest charges, you have to earn $133.33 and then pay $33.33 of it in taxes to get the $100 to send to the credit card company.

3. You’ll have more money to invest, and you’ll be able to retire earlier (if you want to). In my opinion, you’ll be wealthier when you retire, too.

4. You’ll be happier, and you won’t worry about money nearly as much—maybe not at all.

So, how do you go about it? Here are some guidelines that I recommend:

  • Start by buying a copy of Dave Ramsey’s book, The Total Money Makeover. It has some very good advice, and many inspiring examples of people who have gotten free of heavy debt loads.
  • Make a written monthly budget, and include everything in it. Don’t forget to divide quarterly or annual bills (such as insurance payments, birthday and Christmas gifts, vacations, etc.) into monthly portions that you will set aside. Dave Ramsey’s budget worksheet is a good place to start.
  • Use the budget to uncover things you can spend less on. (Don’t be scared. You can do it.)
  • Don’t buy anything new on credit.
  • Save up a small emergency fund first, if you don’t already have one. Better yet, have at least three to six months of expenses in a cash savings account if you aren’t in crisis mode in trying to pay all your bills. Don’t use this money except for an emergency.
  • Next, start paying extra money each month on the principal of your debt with the smallest balance. When you get that paid off something great will happen to you—you’ll feel so good that you’ll be anxious to get the next one paid off. So, get started paying extra on the next bill with the smallest balance. One by one, get them all paid off—including your student loans and cars.
  • Then you can start saving and investing for your children’s college educations, as well as in your 401(k) and Roth IRAs, and to build your wealth.
  • Make your cars go as long as they can, save up as much as you can (hopefully the whole price) to put on each car purchase, and buy “pre-owned” instead of new cars.
  • After all of your other debt is paid off, and you are saving adequately for college and retirement, begin paying a moderate amount extra on the principal of your home mortgage each month.

Of course, these guidelines can’t cover everyone’s situation. Some people have very complex problems or severe amounts of debt and will need professional legal advice on how to address it. If you believe you are in this predicament, don’t put off getting that advice. Face it head on. Do it for yourself and your family.

For most people, the great news is that you can have freedom from the burden of debt. You can be working for yourself instead of the bank. If you commit to it, you’ll probably be surprised at how quickly you can do it. You’ll be happier, feel lighter and less burdened.

Getting out of debt should be an important part of your investment plan. You owe it to yourself.