A Systematic Approach to Eliminating Your Debt

A lot of us may be dealing with minor or major debt. It seems like we can't get ahead no matter how hard we try. If this sounds like you, then listen up: for a small investment of $299.99, I can totally eliminate your debt for you! Okay, I'm totally kidding...but didn't that sound like one of those infomercials you've seen on tv or heard on the radio?

Really, though. I have some debt I need to pay off and, up until this point, I've been paying on it randomly. I'd save some money, pay off most of any particular debt, and then have to save all over again to pay for the rest. I felt like it was taking forever and it didn't feel organized - that's because it wasn't. It was a completely random approach to paying off my debt and I'm glad I found a better way.

What I thought of probably isn't a new concept. I'm sure it's been done by thousands of people but it has proven to be really helpful for me. The goal is to pay off your debt, right? Okay, agreeing with that is step one. Step two is trying to figure out how to do that when you have recurring monthly expenses like rent, food, gas, utilities, etc. If you save a few extra dollars in a given month and you use them to pay down your debt without a system in place, you're always going to feel overwhelmed. The goal is to develop a consistent monthly system to eliminate debt in a specific timeframe without falling behind on your current month's expenses.

Let's look at an example. Chris and Nancy have the following in debt:

1. Electric bills: $300
2. Water bills: $200
3. Personal loans from family and friends: $3300
4. Cell phone bills: $250
5. Dance lesson fees: $100

Total: $4,150

Their combined net (after taxes) monthly income is $4,000. Their total expenses per month are $3700. That leaves $300 each month to use towards whatever they want.

Chris and Nancy currently use that $300 to pay down debt as the person/company requests it. For example if one of their friends asks for a payment because she hasn't received one in a few months, Chris and Nancy will pay something to that friend. The remaining money will go towards other similar situations. Chris and Nancy aren't setting aside any money for savings, either.

Here's what they should do:

1. Examine, re-examine, and re-re-examine their montly budget and cut out all unnecessary expenditures. They can save a lot of money by decreasing their cell phone plans, switching from premium cable to basic cable, buying more groceries instead of eating out, etc.

2. Contact each person or company they owe and ask them to accept a repayment plan. Most, if not all, will graciously accept because they'd rather have consistent payments than random ones.
Chris and Nancy follow the steps above and shave $400 off their monthly expenses. Now they have $700 left over each month. That's a lot of money!

Now, they must determine the percentage each debt is of the total debt. This is determined by dividing the individual debt by the total debt. For example, the unpaid electric bill is (300/4150) x 100, or 7.23% of the $4,150 total. We'll just say this is 7.2%. They'll perform this calculation for all of their debt.

After this is completed, Chris and Nancy should determine how much of the $700 they will save and how much they will use to pay down their debt. Suppose they decide to save $300 and use the remaining $400 to reduce their debt each month. They would take each percentage found earlier and multiply it by $400. The number that results is the monthly payment Chris and Nancy would make to each person or company.

Chris and Nancy would eliminate their total debt of $4,150 in a little more than 10 months:

Monthly Allocation is: $400.00

Personal loans: $3,300.00
Percent of Total: 79.5%
Payment from Allocation: $318.00
Months to Pay Off: 10.4

Electric bills: $300.00
Percent of Total: 7.2%
Payment from Allocation: $28.80
Months to Pay Off: 10.4

Cell phone bills: $250.00
Percent of Total: 6%
Payment from Allocation: $24.00
Months to Pay Off: 10.4

Water bills: $200.00
Percent of Total: 4.8%
Payment from Allocation: $19.20
Months to Pay Off: 10.4

Dance lesson fees: $100.00
Percent of Total: 2.4%
Payment from Allocation: $9.60
Months to Pay Off: 10.4

Total Debt: $4,150.00
Total Percentage: 100%
Total Monthly Payments: $400.00
Total Pay-Off Time: 10.4 months

Notes: Rounding was used in all calculations. Total pay-off time of 10.4 months assumes the debt reduction process is started in the same month for all debt without skipping any future payments.

This may seem like a long time but it is a systematic approach with a definite ending date. Who knows how long it would've taken without this approach. Any extra money earned in a given month by Chris and Nancy can be added to the monthly allocation, thereby reducing the number of months needed to eliminate their debt.

Do you see why this method makes a lot more sense than just randomly throwing money at debt without a clear sense of direction?

You might be thinking, "Manoj, I have credit card debt that require certain minimum monthly payments. I can't use the method above."

That's okay - I have a method for that one, too. Stay tuned...