Getting out of debt doesn’t occur overnight. It may take several years to achieve, and that’s okay. As long as you take it one step at a time and maintain discipline, you will get out of debt and on your path to financial freedom.
There is certainly no shortage of financial advice out there – and it can be tricky to know what applies to you. Your co-worker may be telling you about how you need to save for your child’s education, but you haven’t yet paid off your own student loans yet – what do you do? Use this 5-step guide to find where you are at in your own financial journey, and begin working from there.
1. Get a plan for your student loans
If you still have student loans, and don’t have a plan for paying them off or qualifying for forgiveness, this should be your #1 priority. This is especially important for healthcare professionals due to the high debt load most face. Healthcare professionals tend to also have high potential for loan forgiveness due to many working for non-profit health organizations (such as Mayo Clinic). Decisions you make early on regarding your student loans can have a major impact on your long-term financial success.
Notice this step doesn’t say “pay off all your student loans”. In fact, simply paying down your student loans on a standard 10-year repayment plan could be a six-figure mistake. If you’re working at an eligible non-profit organization, or may in the future, and have a high student loan balance, you should seriously consider pursuing an eligible forgiveness program such as Public Service Loan Forgiveness (PSLF). Due to the long planning horizon and stringent rules, qualifying for this requires planning well in advance.
You should create a plan for your student loan debt as soon as you graduate (or as soon as possible if you already graduated and haven’t already addressed this). Even if you’re not eligible for loan forgiveness, you may still be able to save large amounts of money in interest charges by refinancing your student loans or paying them off early.
If you realize you’re in over your head navigating your student loans, consider hiring a specialist. Some mistakes can’t be undone (such as refinancing a qualifying loan into a loan that will no longer qualify for a forgiveness program). If you choose to delegate this, look for a Certified Student Loan Professional (CSLP®) so you know the professional has extensive knowledge on the options available to you, and has agreed to abide by a code of standards.
2. Take advantage of your employer’s benefits
The most common employer benefit to ensure you’re utilizing is your employer match on retirement contributions (to a 401k or 403b) if they offer this. While this will not eliminate your debt, I would consider this a higher priority than paying off debt. Not only does this savings vehicle offer you tax advantages, you are leaving money on the table if your employer matches your contributions and you are not contributing.
For example, let’s say your employer offers a “50% match up the first 6% of your contribution”. This means if you earn $100,000 per year, and save at least $6,000 into this plan, your employer will also add $3,000 to your retirement savings. If you don’t contribute your part, your employer adds nothing, and your benefit is forfeited. Go out and at least claim the $3,000 your employer has already agreed to pay you!
In addition to your employer match, get to know your complete benefits package and take full advantage of it. For example, many employers (Mayo Clinic included) offer programs to pay for additional college education or certifications. This is a great opportunity to increase your future earnings potential and have your employer pay for you to do so.
If you’re eligible for an HSA (you have a high deductible health plan HDHP), this is another top program to take advantage of. Other unique benefits are becoming more prominent to attract skilled employees, and every plan is different so check with your HR department and co-workers to get to know your specific benefits package.
3. Create positive monthly cash flow
This one is easier said than done, but you are not alone. According to a study done by CareerBuilder, 78% of Americans are living paycheck-to-paycheck. The problem with that is not only is it stressful, it only takes one unforeseen event such as a car repair to leave you scrambling for money. The problem compounds when now you have to take on debt to fill the gap an unexpected expense can create. If this is the step you are at, you will need to prioritize your goals and create a spending plan that works for you.
The formula here is not a difficult one to understand – you need to be spending significantly less each month than you earn. There are 2 ways to do that: earn more money, or spend less.
If you’re struggling, you need to create and maintain a budget. When it comes to budgeting, the most difficult part is just getting started. If you don’t already have a system in place, I recommend any of these 5 tools:
- A pot of coffee, and your favorite spreadsheet tool
- If you’re looking for a template, check out this one I’ve created and customize it to your own situation: Monthly Budget
- Link your accounts online to automatically pull in your transactions
- Like Mint, but instead of being supported with ads and solicitation emails, it costs around $11/month.
- This is a free app for your phone that helps you set up and track your budget, but you manually enter transactions.
- A qualified financial planner can help you get organized and create a budget.
When you’re seeing extra green in your bank account at the end of the month consistently, you’ve taken a big step towards getting out of debt. Your priority should now be to keep it that way by regularly monitoring and updating your budget to stay on track.
4. Create a written financial plan
Your financial decisions up to this point were largely about self-discipline or simply adding to a retirement plan that is already set up for you and subsidized by your employer. Once you’ve conquered those steps, your financial decisions can become more complex and have major long-term trade-offs. To handle the growing number of financial decisions you face, you need a well thought out financial plan in place.
If you have the time and desire to do this effectively – make sure you allocate the time to educate yourself to get this done. A financial plan isn’t a “one and done” thing you do and check off your list. Inevitably, your circumstances will change many times throughout your life. Having a plan in place ahead of time will help you make intelligent decisions as these changes arise. Remember to check and update your financial plan at least annually.
If you don’t have the time or desire (or thought you did, and 6 months have passed and still you don’t have a written plan) consider hiring a professional. If you delegate this – make sure you hire a fee-only, fiduciary, CERTIFIED FINANCIAL PLANNER™ so you know the person you’re paying has transparent fees, is required to act in your best interest, and is a competent professional.
5. Pay off debt
If you have high interest debt, we can finally focus on paying it off at this stage. I recommend using a “debt avalanche” strategy to do this. This involves making minimum payments on all your loans and allocating any extra dollars towards your highest interest rate loan. Once your highest interest rate loan is paid off, begin chipping away at the next one. This strategy minimizes the amount that you will end up paying in total interest over the life of your loans.
If credit cards are a problem, close each card after you pay it off. Simply paying off the card may not be enough to stay out of debt. You should use this opportunity to reanalyze your relationship with debt and form new healthy habits to avoid dipping back into indebtedness.
In some cases where you have high interest debt that will take several years to pay off, it may make sense to refinance your loans. Whether or not that makes sense depends on your credit, current interest rates, ability to pay off a potentially higher payment, and balances on each loan type. You will need to get some quotes and run some numbers to identify the best debt paydown strategy for your situation.
The reason I specifically mention “high interest debt” here is that you shouldn’t necessarily completely pay down all your debt. For example, if you have a low interest mortgage that is well within your means, you may have better uses for your capital at this stage than simply paying down your loan. Also remember to refer to your plan for student loans from step one. Due to the unique nature of student loan debt, you may need to have a separate strategy for your student loans than your other debt.
There is no perfect answer to the “paydown debt or invest” question. As a general rule of thumb, eliminate any debt above 5%. If you look at the interest rate you’re paying and ask yourself “If I could get this return guaranteed in an investment account, would I take it?” If the answer is yes, you should probably just focus on paying off that loan rather than trying to invest the money somewhere else.
If you have realistic expectations about your investment returns and risks, and the interest you’re paying isn’t much more than inflation, it may be appropriate to begin allocating funds towards other things besides paying down additional principal on your loan. Continue to monitor your relationship with debt, and work towards paying down any remaining loans throughout your financial journey.