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How to get out of debt... Spend less than you make!

Here is the Bowen Accounting Official budgeting spreadsheet. Right click and select save as to save it to your computer, open and begin using. Some of the fields are locked so you cannot edit them.

According to the 'Federal Reserve Survery of Consumer Finances' about 1 in 20 American households has more than $8,000 in credit card debt. Getting out of debt is a serious issue facing most adults. Understanding your personal finances and spending patterns is the key to getting out, and staying out of debt.

How much do you make/pay?

The key to getting out of debt is spending less money that you make. How much money do you make? Most people can answer this question. How much money do you need to live on? Most people cannot answer this question, and it is the crux of the matter. As a CPA, when I am dealing with individuals, families, or companies that have financial troubles, the first thing I look at is where they are spending their money(create a budget). I look for all of the items that can be cut from their budgets(cut the budget). When I am done with that, I see if the money coming in is more than the money going out. After that I look at their sources of income, and attempt to show the client how to maximize their income. This does not seem difficult does it?

Why can't people quantify how much they spend?

I don't know the whole answer to this, but I understand at least part of it. Income is easy to quantify because it only happens a couple of times per month, and it does not fluctuate much. You make blank dollars per hour, and work about blank hours per week, and you get paid blank times per month, easy. Spending is more fluid, fluctuates more, and has many more transactions involved in it than income does. As a CPA, I use accounting software to track all my spending and income for my business, my personal finances, and for my clients, but the average consumer does not. I will address how the average person can take steps to get organized using the simplest method possible, paper. However, if you decide you would like to use software to make your life easier, I recommend quickbooks or quicken.

Ignoring the problem

The issue with debt is the same as many other issues in life that people do not want to deal with/ They ignore it. I cannot tell you how many times I sat down with a client to look at their personal finances only to realize that they had disconnected their phone and stopped opening their mail because they wanted to ignore the problem of their debt. Ignoring a problem can make you feel a little better for a little while, but eventually it will come back with a vengeance. This is especially true with debt because your debt will continue to grow while you ignore it. If you have debt and want to get rid of it, then you must face it.

It all adds up

One of the interesting things about numbers, and one of the many reasons I was drawn to the field of accounting in the first place, is that numbers always add up. Numbers are easier to understand than a conversation with a friend or spouse. Language is full of feelings and context, but numbers are unfeeling and logical. 2 + 2 always = 4! That is nice to know. So how do we make the fact that 2 + 2 = 4 work for you? First you must accept that logical math is the beginning of the process to cleaning up debt.

Stop the excuses

Many people believe that they can out earn their debt, or out earn their spending, but the truth is that if you never sit down and quantify how much debt you have, how much you are spending per month, or how much you will have to earn to beat your monthly spending and clean up your debt, all you have is good feelings about something that might or might not happen in the future. There are a lot of other reasons people give about why their budget is not under control, why they don't have a budget at all, why they stop opening their mail, or why they bought a car or house that is too expensive. The bottom line is that debt, and overspending is like an addiction, you must first admit that you have a problem, and be ready to accept the help of others, or at least be ready to help yourself. This usually happens when a you say to yourself or one spouse says to another, I/We make too much money to be this broke.

If you have reached the point where you have had enough and you are ready to make some changes then the rest of this article demonstrates the nuts and bolts of how to get out of debt, and more importantly, how to successfully budget and spend less than you make.

Step 1: Stop using Credit

Sounds easy and it is. Cut up your credit cards and throw them in the trash. You cannot get out of debt by using debt. If you are serious about the process, and you want to get out of debt, you have to commit yourself to begin living on the money you have, and not other people's money. Credit exists so that people can borrow money. Essentially, when you are using credit, you are spending money you do not have. Perhaps you intend to have that money by the end of the month, and then you will pay off your credit card. This is how the use of credit cards usually starts, and then for some reason you make a minimum payment instead of paying off the credit card one month because you had an emergency. Then you have a rollover balance on your card and you cannot catch up the next month. This is the trap of debt when it is used like a savings or spending account. While debt is (sometimes) a useful tool when used correctly in the right circumstances, it is never the correct tool to pay monthly expenses with. However, if you have a card that you pay off at the end of each month then you might as well just use a debit card, and skip dealing with the credit card companies. If you want to get out of debt, you have to be able to pay for your current household expenses with the money that you currently have. You have to stop spending more than you make if you want to get out of debt. It is the first step in balancing your budget, which we will examine next.

Some people will read this section and think it is too extreme. While there are certain types of debt that are reasoanble (a conservative mortgage on a property that is not overpriced) revolving consumer debt like credit card debt is generally a sign that you are spending more money than you make. It is my goal that the information below will help you become more financially educated and more financially secure. The steps are clear and relatively easy to implement. No matter what your opinion about debt, or how you approach getting out of debt, I hope this information helps you.

Step 2: Write it down (make a budget)

The first step in getting out of debt is to see how much money you need to pay your bills each month, and if there is anything left over at the end of each month (a budget). Writing is powerful. Writing down a list of your debts, and writing out your monthly budget will help you understand your current situation as well as help you quantify your situation for the future. Gaining an understanding of your situation and documenting it will allow you to look at what you had originally planned to do, what you did, and analyze your progress. This might sound complicated to some but it is this easy.

  1. Get a piece of paper and write your name, and budget at the top.
  2. Date it and note which month it is for, you should be working on the current month.
  3. Write income, and determine how much money you will bring into the house this month (after tax money). This month might have 3 pay periods, or maybe you always get paid once per month and it is always the same. No matter how you get paid, you need to put a reasonable estimate of how much cash you will have available this month to pay bills.
    1. Note: You may have more than one source of income, you and your spouse, a pension payment, social security, or unemployment. Make sure you list them all, and total them after.
  4. Make a list of all your monthly expenses in order of importance. Below is a basic listing of the most important categories that most people use, in order of importance.
    1. Food
    2. Utilities
    3. Gas
    4. Rent(Mortgage)
    5. Car Payment
    6. Auto Insurance
    7. Personal & Entertainment
    8. Other (Everything else)
    9. Do not list any credit cards or credit line payments here.
  5. Put amounts next to each item representing how much each item costs. You may have to expand the categories to show each individual vendor paid, for instance under utilities you probably have to list water, electric, phone and cable and put an amount next to each one.
    1. I have attached a spreadsheet that I use for my clients at the bottom of this article. It has a good list of the basic items that people use, can be edited, has space for all 12 months, does all of the calculations for you.
  6. Total all of the expenses and then subtract them from the total income, which will give you the total remaining cash available for paying off debt. If the number was negative, then we have a slight problem.

You have just created your first budget. Woooooohooooo! Even if your total remaining cash is negative you are still one big step closer to controlling your money and making it work for you. If you do nothing more than repeat this every month for the rest of your life and live by the numbers you put down on the sheet you are more financially organized than 50% of Americans. However, there is much more to do. The more you do, the more benefits you will derive.

Step 3: Analyze and cut the budget

If the remaining cash available for paying off debt is negative, then you have two options; make more money, or spend less money. In fact, even if the number is positive you can do either or both and accelerate your plan to get out of debt.

How do you make more money? There will be an entirely different article about this topic, but the short answer is , make more money at the job you currently have by securing a promotion or working more, get a second or third job, or start your own business. There is a plethora of ways to make more money if you are willing to work. Note: Extra jobs are a great way to get out of debt, because the more you work, the less time you have to spend money. It sounds silly and clich, but it is true. In addition, when you are done getting out of debt you can quit the extra jobs and have more free time.

Spending less money is a crucial step even if you plan on making more money. If you are going to be working more hours, it would make sense that you are making the sacrifice for a good reason. You want to be making the most headway towards cleaning up your debt, without a bunch of incidental expenses weighing you down. Look at your budget again, and go through all of the items that you do not absolutely need to survive; cable, cell phone, eating out, yard care, personal entertainment are all good areas to cut. Almost every budget has something that could, and probably should, be cut from it. If you do not need it, or are willing to sacrifice the item for a time to be successful in getting out of debt, then cross out the number next to it and make it zero.

Cutting the budget is what most people are avoiding when they avoid budgeting. When you cross out cable, you are crossing out a lot of fun hours of quality entertainment with your friends, loved ones, or alone on the couch. This is another reason that writing it down is important. By crossing out the item on your budget, and writing a zero by it you are making a promise to yourself. You are writing down your intention to sacrifice to make your life better. You can keep paying for cable, and get out of debt slower, or you can cancel your cable for 12-24 months, and use that money to make the next 40 years of your life better.

Note: This cut back budget will only be for a period of time. I generally do not recommend a course of action to get out of debt that takes longer than 24 months. If it is going to take longer than that, you should probably sit down with a professional and get advice that fits your specific circumstances.

Hopefully, all of this agreeing to work overtime, and slashing the budget has made the remaining cash available for debt pay off a big number that you can make some major progress with. Now let's talk about how to pay off those debts.

Step 4: List all your debts and find out how long it will take

In an article called, how to get out of debt, it sure has taken a long time to talk about how much debt you actually have. The reason is that there are so many issues that stand in the way of people making the decision to get out of debt, and practicing the discipline that it takes to accomplish the goal. We had to address those issues before we could face the final number. The final number is how many months will it take me to get out of debt.

Below your list of expenses, make a list of all your credit cards and debts that you have a balance on from the smallest debt on top to the largest debt on bottom. Add up all the balances and the result will be your total debt. This is the number we are trying to reduce to zero. Do not list your mortgage, but do list any home equity lines, and also list your car debt, even though we paid it in the budget above, but do not list the minimum payment, because that is included in the budget.

Next to that list the minimum payments on all of them. Add them up, and subtract that number from your remaining cash available for debt payments. Hopefully that number is positive, if it is not, then you have a problem that can still be fixed, but makes things slightly more difficult. While you are getting out of debt you want to keep all of your debts current by paying the minimum payments. When their turn comes around in the debt snowball, they will get a lot of money thrown at them, but until that time, they just need to receive the minimum payment.

The final number: Divide your total debt by the total remaining cash after minimum debt payments, and this will give you a very rough number as to how many months it will take to pay off all your debts. It should be less than 24 months. If it is not then cut the budget some more, and look at getting some more jobs, and see how you can change that number. If none of that works, then you probably need some professional help.

If the remaining cash after minimum debt payments is positive, then apply the extra money to the smallest debt your have each month till it is gone. After that, take the extra money available, plus the minimum payment from the debt you paid off and apply it to the next smallest debt till it is paid off. This is called a snowball, and as the months roll by the snowball will get larger and larger till you are paying off debts very quickly.

If you do not have enough money to make your minimum debt payments then stop paying all of them but one, and do everything else the same. This is going to cause some problems because you will start getting calls from creditors, and may get sent to collections. It will probably mess up your credit, and the creditors will keep bothering you until you pay them. That is okay, because you will pay them, and sometimes if they have to wait a long time, they will get desperate and want to make a deal with you for only a portion of the debt. This is not an ideal scenario. Before doing this I would go back and cut the budget more, and look for ways to make more money.

Step 5: Throw a party... Also, what do I do now?

When you finish paying off all your debts, you should celebrate. Throw a party, tell all your friends what you have done, take a road trip in that car that is paid for, buy a new computer with cash, buy an overpriced hardcover book from the New York's Best Seller List. Go crazy, just do it with cash, and make sure it is in the budget. You have done what most Americans never do.

Now you have a cut budget, an extra job, no debt, and a pile of money at the end of the month. What do you do now? Well, you should really put enough money in the bank to protect yourself from a major life catastrophe. This is called a reserve account or an emergency fund. It should be about 3 to 6 months worth of your monthly household budget. For most people this is between 15k and 40k. This account will protect you in case of a major emergency like a loss of a job, or a major illness.

The next step, which will be covered in other articles, is to start putting your money where it should be. Investing for the future, making sure you have the appropriate insurance coverages, and living your dreams. Please see our list of articles for these other topics.

Some notes:

You should have a reserve account of about 1,000 before you start paying all of your extra money towards debt. This savings should protect you from any emergencies that come up, while you are working towards getting out of debt. There are not a lot of emergencies that 1,000 cannot fix. If an emergency comes up and you have to use that money, then halt your extra payments till the money is put back in the reserve account. Basically, you are borrowing money from yourself. How does it feel to be the bank, instead of borrowing money from the bank? Nice right.

Most people have to do a monthly budget for almost six months before they get really good at it. Once you get good at it, don't stop doing it. You should have one budget sheet for every month of your life, or one large sheet that lists all 12 months of the year that you work from. In the next year Bowen Accounting will be rolling out our online budget and expense tracking system that you can use to replace the paper.

You may have questions about your specific situation and how the practices above will work for you. Please feel free to contact Richard Bowen. This service is free to my tax clients, and very reasonably priced to others.

Here is the Bowen Accounting Official budgeting spreadsheet. Right click and select save as to save it to your computer, open and begin using. Some of the fields are locked so you cannot edit them.