Imagine how it would feel to have no worries about debt as part of your life. There is a simple, but powerful way to get out, and stay out of debt. It’s a strategy I call “Saving Your Way Out of Debt”. The following are the simple —though not always easy —steps of this process. Connecting saving money to stabilizing, reducing, and eventually eliminating debt is a cornerstone to building a healthy relationship with money; a way of living that I call Financial Recovery.

People get out of debt all the time. Similar to yo-yo dieting where weight is lost then regained, debt is often paid off, then old habits resume and we find ourselves carrying a heavier debt load than ever. The real challenge is staying out of debt. So here are the first five steps to breaking the debt cycle forever. Stay tuned for part two next week.

Step 1: Avoid Deprivation Mode

Most people assume that they must cut out everything that is fun or pleasurable until their whole debt is paid off. Leaving essential emotional and physical needs unmet sends us into deprivation mode. Deprivation often leads to overspending. Overspending often leads to more debt. Identifying your essential needs and building a spending plan that meets them (even in simple ways that don’t involve spending money) is vital to feeling satisfied throughout the process of eliminating debt. (I will talk more about dealing with deprivation in other posts.)

Step 2: Stop the Leaks by Stabilizing Debt

Starting prematurely with paying down your debt while you’re still either using your credit cards (or in danger of using them if something happens) keeps you stuck in the debt cycle. This is like sitting in a boat with a grapefruit-sized hole in the side and bailing out the gushing water with a thimble.
The first, and most foundational step to freeing yourself from the debt cycle, is debt stabilization. It’s nearly impossible to continue to use credit cards while stabilizing your debt. Stabilizing debt simply means that you stop adding to it. That’s right- step two means it is time to stop using your credit cards. You simply can’t get out of debt if you are still using your credit cards.

Step 3: Build a Firm Foundation with Periodic Savings

One common myth is that we can’t begin saving until we are debt free. In fact, saving right from the start — even while you’re paying down debt — is the key that will free you from the yo-yo of the debt cycle forever. Start by building Periodic Savings. This is money available for use to meet periodic, non-monthly expenses, such as car insurance, taxes, and family vacations —that’s right, the obligations and the fun stuff. Periodic savings is key to making your entire financial life work over time.
The one thing you can be sure of is that “life happens.” Surprises will always crop up. Without any available cash, we must resort to credit cards. Then we’re back in the leaky boat again, baling away.
How do you save when money is already tight?
• Start by making minimum payments on all but one targeted debt.
• Reduce optional spending, without depriving yourself of your most important needs.
• Add to earnings. With the motivation of saving money and eliminating debt many people find new motivation and creativity for bringing in more income.

Saving Your Way Out of Debt may seem slow at first, but eliminating debt forever will pay for itself a thousand times during the course of your future financial life. So step three is to start saving money, even a small amount, every month, while still trying to not use your credit cards.

Step 4: Use Periodic Savings Guilt Free!

Most of us feel that savings are not to be touched, and if we do use the money, we feel as though we’ve failed. Periodic Savings is meant to be used, guilt-free, for periodic or non-monthly expenses rather than charging them. So step four is to actually use your new savings for those expenses that would end up on a credit card.

Step 5: Reduce Debt with a Proven Strategy

Once debt is stabilized and you’re building your Periodic Savings to keep it stable, you are ready to start reducing debt.
I teach a method that I call “snowballing” for repaying debt. Here are the simple steps:
• Arrange all of your credit card debts from the lowest balance to the highest.
• Make minimum payments on all but one targeted debt. (Some people choose the one with highest interest first. I like to choose the one with the lowest balance so that I can get that sense of accomplishment more quickly.)
• Designate whatever amount above the minimum that you can pay toward just the targeted debt.
• When the targeted debt is paid, roll the entire amount you were paying onto the debt you want to target. The “snowball” grows as you pay each debt off. You pay the same amount toward debt repayment every month, but that amount “snowballs” until you’re eventually paying the whole amount toward that last debt.
Of course, the higher your debt, the slower the process of debt reduction. But please, reassure yourself: going slowly in the right direction is enormously better than going in the wrong direction at any speed.
Tune in next week for part two- steps 6 to 10.

May 10th, 2011 by Karen McCall