The problem of getting out of debt is a real close one for my wife and I. After a couple of years of rationalization and no results, we continued to be in debt (about $25,000 in early January 2006). Although we were making more money than ever before, the debt didn't seem to go away. So we decided to try a different approach. After reading D. Ramsey's "Total Money Makeover", we started a plan with a fix goal: to be out of debt by the end of the year.
Since I am a bit more organized than my wife, I took the job of playing with budgets and determining if the goal of being debt free by the end of the year was achievable with our current income. I determined that we needed to have $2,500 a month for debt (car loans, credit cards, medical bills) reduction.
After a couple of hours of work, I came out with a budget. We discussed the pro's and con's of the plan and after some modifications, we we're ready. After the first month, we had to do some changes, but the general structure was mantained. After that, we were on automatic pilot. We used the snowball debt reduction method
(order your debts from lowest to highest, and make payments in that order).
Today, it only remains to send a payment of $500 for American Express and we will be done. Yeah, we didn't achieve the original goal, but the due date is Jan 2nd., so I don't mind if we missed the original goal deadline but a couple of days.
Now that I have told you my story, I will outiline the plan:
0) Prepare a budget
. Fill first your housing and food, then transport and finally debt. This is suitable for both fixed and variable incomes. If you have some savings, stop it for the moment. Create an emergency fund of $1000, and take the rest toward debt reduction.
1) Add up the minimum payments for each one
. If you have enough proceed to step 3. If not go to step 2.
2) Increment your income. Deliver pizzas, do freelance jobs, sell stuff your not using and is draging you down; what ever you need to get out of this situation. It is only termporary.
3) Make minimum payments in all except the smallest debt
. Pay as much as you can on this one. If you don't have enough to knock it out, don't worry, you can do it next month. On the contrary, if you made a payment in full, proceed with the next smallest debt and repeat.
4) Next month, repeat from step 3.
The idea is that your total figure towards debt reduction remains constant month to month. Then, if you have fewer debts, you can make larger payments (hence the snowball effect) and get out of debts faster.
This is not an optimal plan, in the sense that it is possible to pay more in total interests than using other methods, but it will get you there sooner.
I hope my description is not too complicated, but if you have any doubts, do not hesitate on leave me a PM.