How to REALLY consolidate your debt

matthew's picture

Getting out of deep debt isn't easy. It's a process that takes time, diligence, and attention to detail. You can do it by yourself, or you can find a lot of people willing to do it for you... for a fee. I'm going to talk about building a successful strategy for your own debt relief, and then touch on available options for those who can't – or won't – do it by themselves. I plan to talk about some tools I've used to help with this in the past, and some simple strategies to help you achieve your financial goals without additional loans, grants, or commercial debt consolidation program.

Paying off debts – particularly if you need help paying off payday loans and other high-interest loans – requires a strategy. The very first step, before you start shopping around for debt consolidation, is to know EXACTLY where your money is going and where it's coming from so you have an accurate picture of your financial situation.

Step 1: Figure Out Where You Stand Today

If you're married or cohabiting, that means the much-dreaded budget meeting. Grab a copy of your bank statement. Write down your income and how much you can expect each month. Then write down all your expenses, down to the last penny, that you incur each month. Even if you got into debt due to irresponsible spending, document it here so that you know the truth. If you don't know what you've spent your money on, take your best guess. You'll revise it over the weeks, months, and years it will take to get out of debt, and eventually you'll have a very accurate picture of where your money is going.

It's always better to know the truth. Even if the truth is painful to bear! If your spouse has a lot of unexplained expenses, prepare yourself for the worst.

Step 2: Learn How To Manage Your Finances

Now, I'm not LDS, but the LDS church publishes a free pamphlet called “One for the Money: Guide to Family Finances” that is really useful to get you started in your road to financial freedom. The pamphlet outlines a strategy for paying off your debts that is guaranteed to work if you follow it – no pun intended – religiously. The pamphlet is available as a downloadable PDF file, and if you're reading this, you certainly have a web browser that will do the trick! I think the only negative aspect of the pamphlet is its intense focus on religious values to motivate you to budget your money. But the positive aspect is that it outlines a successful strategy toward eliminating debt: pay the minimums on everything except for your one highest-interest loan. Once that is paid off, then apply that entire amount to your next-highest-interest loan. My wife and I have applied this strategy for the past decade, and have successfully paid off everything except for our home mortgages on two properties.

It works. Use it, if you can. I can testify to its usefulness, and our lack of significant debt besides our houses is a key to our ongoing financial success.

Step 3: Use The Right Tool For The Job

If the above pamphlet doesn't quite do the trick for you – if you'd like a system to get out of debt fast – then I recommend YNAB, or “You Need A Budget”. The basic rules of YNAB will give you a successful strategy to live within your means... and the price for the tracking software is extremely reasonable (less than $50). I've used his spreadsheet-based product before, and within a few weeks of using it you'll see exactly where your money is going and where you need to reduce spending to get your credit card usage under control. YNAB lives by the Four Rules:

Rule 1: Stop Living Paycheck to Paycheck. Live only on the income you earned LAST MONTH, with this month's income in the bank.

Rule 2: Give Every Dollar A Job. Plan exactly where each dollar will be spent. If you think you “never know”, that's part of your problem!

Rule 3: Save for a Rainy Day. Even the tightest budget can find some room to put away a few dollars to cover those unexpected – yet common – big expenses.

Rule 4: Roll with the Punches. You're never going to be perfect with your budget. Keep adjusting over time to try to meet your goals, but don't expect perfection!

I have no doubt that everybody can find a way to live within their budget. It may require adjustments to your living conditions, but making and following a budget is vitally important if you don't want to go bankrupt! You don't have to live paycheck-to-paycheck anymore once you start following some simple budgeting principles.

But what if your credit truly is out of control? What if you're so deep in debt that, after doing the budget, you have no money left to live on after paying your obligations each month?

Step 4: Credit Counseling and Preparing for Bankruptcy

There is help available, and you should really avoid ads for out-of-state debt consolidation programs. Debt consolidation can be a nightmare if done wrong! The Federal Government of the US offers a list of state-by-state approved credit counseling agencies. These organizations will often negotiate with your creditors to reduce your payments or forgive certain debts so that you have enough to live on. If you think you might need to file bankruptcy, these organizations are a required stop before you're allowed to do so. The fly-by-night Internet ad you found won't do the trick... you're going to HAVE to see one of these agencies. But realize, there are important costs:

  1. Paying less per month means you're going to pay more – a LOT more – in interest over time.

  2. It's going to show up in your credit report. Agencies that claim that there will be no hit on your credit report are usually relying on fraud – like a false Social Security number – to achieve their ends. Expect a HUGE hit and an inability to obtain credit from now on. If your budget is so bad that you're considering credit counseling rather than the free or low-cost alternatives above, you may not care at this point, but it's important to expect it.

  3. There's usually a substantial fee for the services of the credit counseling service. If they offer free credit counseling, they are usually making their money on the back-end: taking a fee from your payments before handing them over to your creditors.

  4. Beware of “balloon” offers. They'll suck you in with a very low payment, but at the end of a certain number of years – typically five to ten – you have a very large payment that you need to pay off, and a need to obtain new credit to finance it if you don't have the cash to pay it off. With the hit on your credit history outlined in #2 above, you have a good chance of being denied a reasonable loan!

  5. Beware of “variable rate” offers. They'll offer you a very low rate at first to suck you in, but as payments expand over time often these very low-cost loans turn into an unimaginable nightmare to pay off.

You Can Do It!

Look, I think you have the skill set to do this yourself. Grab a copy of YNAB, grab that pamphlet for how to manager your money that the LDS church publishes, and figure out your strategy. You can do it! Credit Counseling – and “debt consolidation”, as bad of an idea as it is – is really your last stop before declaring bankruptcy. If you're overwhelmed by medical bills, you can make a good case for declaring bankruptcy on that basis. But avoid those two options unless you really, truly have no other choice.


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Sammy G's picture

Additional out-of-debt thoughts

Matt, nice post! You obviously took a lot of time to organize thoughts for something that was a personal experience.

Re: Step 1, Figure Out Where You Stand Today goes way beyond a monthly budget. I find that a monthly budget is not an effective tool for family financial planning, regardless of the state of financial condition (retirement savings, debt relief, etc.). There are several reasons for this, but they all follow the same principle that a monthly calculator disables a full calendar cycle's worth of spending. Certain types of expenses, such as insurance, lump-sum for renewal at one single time during the year. Meanwhile, we don't always spend our out-of-pocket max on health insurance evenly each month. Furthermore, specific withholding and FICA taxes deplete at certain income levels and at certain times of the year. Finally, and most importantly, tax planning has such a huge impact on a household cash flow, and this is rarely factors into a short-term (monthly) budget cycle thinking.

Overall, a budget, including income minus expenses, is just a snapshot of a larger 'Estate Planning' collage. The Estate Planning calculator needs to take an ANNUAL view for pre-tax commitments, employer matching, tax withholding rates, total fixed expenses, and tax impact. From this calculator can be computed an 1) annual discretionary savings and 2) annual total savings. Keep in mind that these final numbers aren't exact. It's a rough estimate for decision purposes. As Matt wrote, this is all a decision tool.

In addition to the Estate Planning calculator should be a separate document that assesses the current household Balance Sheet. This Balance Sheet includes investments, assets, savings accounts, current debt, and long-term debt. It's good to update this once a month after the month-end statements arrive. The combination of an annual Estate Planning calculator, for discretionary savings, plus a Balance Sheet provide a holistic collage of both a current AND future state of affairs. Again, good to know where you are currently and where the household is heading.

Once this is done, I think it's good to then move to an Analysis phase. This would be my Step 2. I think this Analysis phase is where the dreaded elements of the budget meeting Matt mentioned emote. Hence, the analysis phase might include an outside expert; someone you trust who is in the financial planning business. Again, might include an outside expert. The outside expert is a third party who can navigate emotions by offering a calming keel against the rough seas of irrationality ("but I NEED my daily Starbucks!").

As far as Step 3, I've gotten out of debt over long periods of time. My approach has always been to confront the creditors and prioritize payment based on capability. Student loans are a good example. What is Sallie Mae gonna do, repo my brain? So you can confront and work out expectations on repayment based on ability and creditor feverishness. Step 3 - Confront and Prioritize.

I would consider Matt's Step 2 - Learn How To Manage Your Finances - less of a Step and more of a lifelong process. It's not easy for some people to learn by sitting at a table for one meeting. Some people just aren't wired this way. Just my experience.

I will circle back again to tax planning. Most people who are burdened by debt never think about the tax planning cycle as an important piece of returning to financial buoyancy. In fact, most people don't think about tax planning as an important part of managing their household planning. From reading my past posts, y'all know how critical I view U.S. tax policy. At the household level, if you are discovering your tax position when you do your taxes you are way too late. You should know your tax position before the calendar year is out. Otherwise, the government wins.

Hope Matt's lead and my follow-up are useful.

matthew's picture

Great response!

Great response, Sammy! I appreciate your insight. You've experienced the difficulty of running your own business, struggling with startup costs, and living within your means while doing so. Your input is extremely valuable and based on hard-won experience.

Matthew P. Barnson


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