Step Three - How to Get Out of Debt

There is really one way to get out of debt: pay it off. This means using your money less for other things until the debt is paid off. This sounds excruciatingly simple, but every day millions of indebted Americans buy things they don't need while remaining in debt. This post by Mr. Money Mustache explains it better than I ever could.


What if my debts are "Good Debts"?

A "Good Debt" is a debt where you come out ahead in the end. For example, if you borrow money to buy a house because buying is significantly cheaper than renting in your area. Student loans can possibly fall into this category as well because they can boost your earning potential.

Just because your debt was a "Good Debt" doesn't mean that carrying the balance any longer than you absolutely have to will do you any favors. You will come out further ahead if you focus on paying it off.

There is a rare exception to this for very very low interest debts (under 3%) where you could make more by investing the money than paying it off. This is called leveraging, or investing borrowed money, which inherently has some risk.

How do I even start?

In the personal finance world, there are two debt strategies that are most popular. They're called avalanche and snowball.

In both methods, continue to make minimum payments on the debts that you aren't "working on". Otherwise they could incur late fees or even be sent to collections!

In the avalanche method, debts are paid highest-interest-rate first. In my opinion, this is the only logical way to do it. You free up money faster that you were paying on interest.

In the snowball method, you start with the debt with the smallest balance and pay it off completely- then move up from there. This will end up costing you more in the long run, but lots of people swear by this method because of the happy feelings of encouragement they get from paying off a single debt completely.

I don't like the snowball method. Those happy feelings of encouragement have a real cost- the money that you could have saved by paying debts off in the right order. Go to unbury.us and plug in your debts. You can click between avalanche and snowball to see the exact price of those happy feelings.

There are lots of happy feelings you can get that you don't have to pay for, like playing with other peoples' dogs.

Plus, if you have less money being sucked away by interest, it will help you get debt-free even faster. Talk about happy feelings of encouragement!

A great tool out there is unbury.us - pop in your loans' info and make a plan.

Doesn't having some debt help my credit score?

You should NEVER pay interest to boost your credit score. If you already have debts, the best thing you can do is pay them off. If you have no credit history, open a credit card, make one purchase on it each month, and pay off the card before interest has a chance to build up. With a good rewards-type credit card, they'll even pay you to boost your credit score!

Be warned: after you pay off a debt, your credit score may temporarily drop.
You can google around to read the panicked tales of Yahoo Answers contributors wondering why their credit score dropped after they paid off a debt. The best answer I can give is that credit scores are based on a lot of goofy variables including how many different credit accounts you have, and they're a measure of how profitable you are to the creditors, not a measure of how good a person you are, so chill. Give it time, and it will rise again, like a zombie clown.

It may take you a long time to climb out of debt. The more you make it a priority, the faster it will go. When you're ready to move on to Step Four, your first stop will be an IRA...

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