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JULY 2021
The 7-step plan to getting out of debt
It’s said that a journey of a thousand miles begins with a single step. The same is true for getting out of debt. By breaking up the challenge into seven doable steps, you’ll gradually take back control of your money and put your debt behind you.
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Step 1 – Save $1,000 for your starter emergency fund
In this first step, your goal is to save $1,000 as quickly as possible. Your emergency fund will cover those unexpected life events you can’t plan for. You don’t want to dig a deeper hole while you’re trying to work your way out of debt.
Step 2 – Pay off all debt (except the house) using the debt snowball
Next, it’s time to pay off the cars, the credit cards and the student loans. Start by listing all of your debts except for your mortgage. Put them in order from smallest to largest balance, regardless of interest rate. Pay minimum payments on everything but the smallest one. Attack that debt with a vengeance. Once it’s gone, put that payment toward the second-smallest debt, making minimum payments on the rest. That’s why it’s called the debt snowball. Use it to knock out your debts one by one.
Step 3 – Save 3 to 6 months of expenses in a fully funded emergency fund
You’ve paid off your debt! Don’t slow down now. Take that money you were throwing at your debt and build a fully funded emergency fund that covers 3 to 6 months of your expenses. This will protect you against life’s bigger surprises, like your car breaking down, without slipping back into debt.
Step 4 – Invest 15% of your household income in retirement
It’s time to get serious about retirement — no matter your age. Take 15% of your gross household income and start investing it into your retirement. Start with Costco’s 401(k) plan — 1165(e) in Puerto Rico — and invest up to the full employer match.
Step 5 – Save for your children’s college fund
By this step, you’ve paid off all debts (except the house) and started saving for retirement. Next, it’s time to save for your children’s college expenses. Experts recommend 529 college savings plans or ESAs (Education Savings Accounts).
Step 6 – Pay off your home early
Now bring it all home. Your mortgage is the only thing between you and complete freedom from debt. Any extra money you can put toward your mortgage could save you tens of thousands of dollars in interest.
Step 7 – Build your nest egg
You know what people with no debt can do? Anything they want. That’s why the last step is the most fun. Keep building your nest egg and be generous, whether that means leaving something for your kids or giving to a cause that’s important to you.
Source: Ramsey Solutions, 7 Baby Steps, 2019.