We celebrate Independence Day with thoughts of freedom, security, and the pursuit of happiness. Yet, for many, their financial situation tells a different story. If debt is a constant pressure, that ideal of true freedom can seem out of reach. Luckily, taking control of your finances and tackling that debt head-on can pave the way to your own “financial independence day.”
We’ll cover clear, actionable steps you can take right now to begin your journey toward debt freedom and a more financially independent future.
Step 1: Understanding your current situation
The first step to financial freedom is to understand where you currently stand so you can make a plan. This step is not always easy, but it is absolutely essential. It’s a necessary step that helps you build a debt repayment plan that actually works.
Calculate your total debt
To effectively tackle your debt, you need to know the full scope of what you owe. This involves listing out every single debt you currently hold. This might include:
- Credit Cards: Balances on all your credit card accounts.
- Student Loans: Federal and private student loan balances.
- Auto Loans: The remaining balance on your car loan(s).
- Mortgages: The outstanding principal on your home loan(s).
- Personal Loans: Any loans from banks, credit unions, or online lenders.
- Medical Bills: Outstanding balances for healthcare services.
- Other Debts: This could include money owed to friends or family, payday loans, etc.
Once you have this list, add up all the outstanding balances. This total is how much debt you’re currently carrying. Knowing this number is the first clear step in your plan to get out of debt.
Review your income and expenses
Understanding what’s coming in and what’s going out is just as important as knowing your total debt. This involves a detailed look at your income and expenses:
- Tracking Income Sources: Write down all sources of income, whether it’s your primary job, side hustles, or any other regular earnings. Calculate your net income (after taxes and deductions).
- Categorizing and Tracking All Expenses: For a period of at least a month (or longer for a more accurate picture), meticulously track every single expense. Categorize these expenses into two main groups:
- – Fixed Expenses: These are recurring costs that are generally the same each month, such as rent or mortgage payments, car payments, insurance premiums, and loan minimums.
- – Variable Expenses: These are costs that fluctuate from month to month, such as groceries, entertainment, dining out, transportation costs (gas, public transit), and shopping.
- Identifying Areas Where Money is Being Spent: Once you’ve tracked and categorized your expenses, analyze where your money is actually going. You’ll likely find areas where you can cut back or make adjustments.
Calculate your debt-to-income ratio
Your debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes towards debt payments. To calculate it, divide your total monthly debt payments by your gross monthly income. Understanding your DTI can not only reveal the current strain of debt on your finances but also help you assess the feasibility of different debt repayment options in the next step.
Step 2: Make a debt repayment plan
To really attack your debt, you need to know how much money you can put towards it each month. Create a budget that shows where your money is going and where you might be able to spend less. If making a budget feels tough, remember that non-profit credit counselors can help you with this for free. They can give you a clear picture of your finances.
Next, think about how you want to pay off your debt. There are a few common methods that work for many people:
- Snowball Method: You pay extra on your smallest debt first to get quick wins.
- Avalanche Method: You pay extra on the debt with the highest interest rate to save money in the long run.
- Debt Consolidation: Debt consolidation involves combining multiple debts into a single, ideally lower-interest, payment. Two common DIY methods are:
- Balance Transfer: Moving high-interest debt to a credit card with a lower rate (typically requires good credit and stable income).
- Consolidation Loans: Taking out a new loan to pay off existing debts (also usually requires good credit and stable income).
Choosing the right plan can feel overwhelming, and that’s okay. Credit counselors can also advise you on the best debt repayment strategy for your situation.
For some, these DIY methods may not be the best solution. Luckily, professional help is available. Credit counselors can set you up with debt management programs, which is where your counselor works with your creditors to potentially lower interest rates, stop fees, and create a structured repayment schedule. For more serious financial challenges, they can also explain options like debt settlement programs or bankruptcy, so you understand all the possibilities.
Step 3: Sticking with your plan and staying motivated
You’ve got your budget and debt payoff method – great! Now comes the hard part, staying on track. Here are a few things that can help you along the way:
- Check your progress often: See how much debt you’ve knocked out and acknowledge those victories. It’s encouraging to see you’re moving forward.
- Keep your eyes on the prize: Remind yourself what being debt-free will allow you to do. Those future possibilities are strong motivators.
- Lean on others: Find a friend or online community for support and to share your journey.
- Be ready to adjust: Unexpected things happen. If your situation changes, tweak your plan, but keep going.
- Celebrate wins (smartly): When you hit a debt payoff milestone, reward yourself in a small, budget-friendly way to stay motivated for the long haul.
Final thoughts
The journey to freedom from debt takes effort, but the reward is significant: true financial independence and security. Start today, stay focused, and look forward to celebrating your own Financial Independence Day, free from debt and full of possibility.
