You are aware how debt limits your opportunities and disturbs your financial life. Also, if you are asking yourself “does debt hurt my credit score?” then yes, it brings it down too. Your debt could be a result of various actions. It could be that you had not anticipated certain medical emergencies, educational expenses or any other unavoidable expense or it could be a result of your relentless spending. Whatever the reason, you have now realized that you want to get out of the debt zone. Here are some practical tips that could get you out of debt:
Create A Plan and Stick to It
Get a piece of paper or open a Google Spreadsheet on your computer. Write down all the amount you owe and plan to clear out all the debt in the next 6 months or any other realistic duration. Chalking out a good plan and religiously following it gives you the determination to come out of your debt. A good debt payment plan involves identifying the areas where you spend your money regularly. You can start by maintaining a spending journal. Many times, we neglect the seemingly minor expenses which mount up to become a decent amount.
At the end of the month, you can manage your money by identifying and eliminating unnecessary expenses. You can try to cut off on some expenses which you can live without such as your YouTube premium or Netflix membership, eating out, clothes, etc. These expenses, although small, may accumulate to become a great saving once you start noting them.
Lower Your Debt to Income Ratio
Your debt-to-income ratio is all your monthly debt payments divided by your total monthly income. This is one of the ways how lenders measure your ability to manage the payments you make every month to repay the money you have borrowed. For example, if you pay a house loan EMI of Rs. 35,000/-; Your Car EMI of Rs. 10,000; and another Rs. 2000 for the rest of your debts with a monthly income of Rs. 90,000/-, then your debt to income ratio will be ((35000+10000+2000)/90000) *100 = 53%. This indicates an unhealthy debt to income ratio.
The ideal debt to income ratio should be 30% or less. Don’t worry if you are not there yet for it is understandable that conditions will not always be perfect. But you can always try to slowly and steadily push yourself below the 30% mark by avoiding further unnecessary debt. While you are at it, keep a track of the developments in your credit score. You can check your free credit score on CRIF High Mark.
Focus On Clearing One Debt at A Time
There are two approaches to go about clearing off your debt, one at a time. The first way, known as the debt snowball, is to make a list and pay off your debts amounting in the ascending order, i.e. from smallest to largest, regardless of the interest rate. The point is to tackle the smallest account at a time and eventually snowballing into larger ones. While this method might accelerate your debt clearance and may give you the confidence to tackle the larger debts as you go down the list, it is not a mathematically sensible method as we aren’t considering the interest rates here. This is where comes the more logical technique called the debt avalanche or laddering.
In laddering, you arrange your debts in the descending order of their interest rates. The one with the highest interest rate becomes your priority. Here you make the minimum payment for every account except the one that you are trying to get rid of first. For this debt, you try to pay the maximum possible amount to clear it off as early as possible. Once that debt is paid completely, move on to the card with the second highest rate and so on. By doing so, you clear off the debt with the highest interest rate and will save the most money. Remember to NOT close the account once the balance is paid off as that will damage your credit. Just let the account sit at zero balance.
Stop (Ab)Using Your Credit Card
One of the easiest ways you can come out of debt is by avoiding going further into debt. One of the factors which keeps you clinging to debt is the use of your credit card. Using a credit card rampantly only serves to add more debt on you. So stop using your credit card, at least for a while, until you get yourself out of debt. This would also add discipline to your life when you stop spending on everything your card can buy. Moreover, your credit score would also benefit hugely as this would bring down your credit utilization ratio.
Sell Your Unused Items
Just a look around your house and you will find that there are a lot of unused items which you are better off without. It could be the pile of newspapers and books, your old printer or DVD player, or even an extra motorcycle, depends on what you need the least right now. In this way, you can also earn some extra cash!
If you follow the above steps diligently, coming out of debt will transform from a distant dream to a cake walk!