Mailbag: 5 Steps To Get Out Of Debt

I received this email from “Alan,” a 24 year old who was just hired after being unemployed for 8 months after graduating college.

I am in $15,000 of credit card debt and got a job that pays $60,000/year. I was living with friends without really paying rent and now that I’m moving out into the real world, I have no idea what to expect once I get there. I have to pay for rent, utilities, food, and car payments, I’m not sure how much I should set aside for debt, retirement, and savings. How should I allocate my funds?

Alan seems to be in a fairly similar position to me, although his credit card debt is likely accruing interest at a faster pace than my student loan is. I would recommend 5 steps to get started building savings and tackling the debt.

1. Track Expenses

Go right now and sign up at Mint.com. It’s hard to predict exactly how much you’ll spend on lunch with co-workers, fun, and other expenses. Don’t worry about creating a budget just yet, but be responsible with your purchases. Keep in mind that you’re in debt and are trying to get out.

2. Build $2,000 Emergency Fund

After paying the minimums on your credit card, throw everything else into an emergency fund. Some people suggest that $1,000 is enough to get started, but the truth is that $1,000 may not cover what you need. If something happened to your car or if your job doesn’t work out for some reason, this is what you’ll have to rely on. $2,000 should provide you enough of a cushion at the beginning, and after you have that much, keep contributing a small amount each month to give yourself more to fall back on. Every few months, check back on this emergency financial file and keep adding because as you work more, you’ll have higher expenses and will need a bigger cushion.

3. Build A Budget

Once you have an emergency fund, it’s time to see how much you can afford to throw at the debt. Use Mint to build a budget based on your expenses in the first 2 or 3 months, and cut out what you can. Stick to your budget and you’ll see the debt decrease.

4. Aggressively Pay Off Debt

Anything you have left over after expenses and what you put into the emergency fund, write a check to the credit card company. This number will fluctuate depending your living situation and city you live in, but more you pay now, the less you’ll pay overall. Imagine the feeling of being debt free!

5. Work Hard

While focusing on getting out of debt is great, keep in mind that it will be a slow process. Over time, the mound of debt you have will decrease slowly and surely, but it shouldn’t be all you think about. Focus on your job. Improve yourself, work hard, and get noticed. If the debt is gone but you don’t have a job, then you’ll be right back to where you started. The best thing you can do is to do you job well. Having that job will be much more valuable than the emergency fund.

For now, I am going to suggest passing on the retirement savings because the interest rates on your credit cards are likely higher than the rate of return you’d get in your retirement account. Once you have the debt taken care of, you can start pouring all that money you were using to pa off the debt and instead use it to build a healthy emergency savings account and retirement fund.

What other steps should Alan be taking to get out of debt?

If you have a question you’d like answered, please don’t hesitate to contact me!

2 Responses to Mailbag: 5 Steps To Get Out Of Debt

  1. Ken says:

    I couldn’t determine if he was moving out right away or not. If he’ll be there another month I would pile up money for rent and deposit. I’m unsure what that amount would be given where he lives. I think $1000 as a minimum. He needs to get the 5 basics down: food, utiliites, housing, and clothing and transportation. Anything above that can be thrown as extra toward credit card debt.

  2. I think you’ve covered all the basics!

    The big thing is to aggressively pay off debt- it’s so easy to say “ooh I’ll do it next month”…

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