Blog | Personal Finance

The Successful Strategy to Get Out of (Bad) Debt

Are you buried under credit card debt? Is your car loan driving you crazy? Follow these six steps to get out of debt.

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Whether it’s from your credit card, your college loans, your car loan, or some other liability, being in debt is a blow to our confidence. Here are six simple steps to get out of debt.

According to the Federal Reserve Bank of New York, there has been a significant increase in total household debt as of the first quarter of 2022. At $15.84 trillion, balances now stand $1.7 trillion higher than before the COVID-19 pandemic towards the end of 2019.

The sad reality is that Americans are taking on more bad debt, and it could be the canary in the coal mine for another recession.

The definition of poor

When discussing debt, I can’t help but to recall the words my rich dad said to me long ago regarding the game of debt: "The more people you're indebted to, the poorer you are. And the more people you have indebted to you, the wealthier you are. That's the game."

Rich dad went on to say, "We're all in debt to someone else. The problems occur when the debt gets out of balance. Unfortunately, the poor people of this world have been run over so hard by the game that they often can't get any deeper into debt. The same is true for poor countries. If you have too much debt, the world takes everything you have, including your time, work, home, life, confidence, and even your dignity.”

Essentially, debt is inevitable - but can work to our advantage if we play our hand right. So what exactly is good debt?

Understanding good debt vs. bad debt

For many people, debt is a four-letter word. The conventional wisdom is to tell people to stay away from it like the plague. Many financial gurus have built their whole empires on decrying debt and helping getting people out of it.

At Rich Dad, we don’t feel this way about debt. Rather we make an important distinction between two types of debt: good debt and bad debt.

Bad debt is debt that is used to purchase liabilities such as cars, vacations, clothes, and even emergency funds for things you simply don’t have the cash to cover. Why is it called bad debt? Because it doesn’t make you richer. It makes you poorer. This is because liabilities take money out of your pocket each month, not put money in them.

Good debt, on the other hand, is debt that puts money in your pocket each month. It makes you richer. It is used to purchase things like investment real estate, grow your business, or take advantage of other investment opportunities. In short, it is used to purchase cash-flowing assets. The cash flow from those assets pay for the cost of the debt.

Unfortunately, most people in America are saddled with bad debt and have no idea how to put good debt to work for them. And the reality is that before you can put good debt to your advantage, you really need to take care of your bad personal debt.

Kim and I had the hardest of times when my first business failed. I personally had over $1 million in debt that needed to be paid off; this ultimately led to us living in our car for a short time. Despite the emotion associated with a devastating blow, we refused to give in to the temptation of rolling over and getting a job. Instead, we made a plan.

Using all we had learned about money and how it worked, we looked for great opportunities to build our asset column—and eliminate our personal consumer debt—bad debt. By implementing this plan, we were completely debt free within a few years and on our way to financial freedom.

The six simple steps

Alright, Finally, the six steps. The following steps can be used to eliminate your personal debt. If you implement them, they will work.

Step 1 - Limit your bad debt

If you have credit cards with outstanding balances, discipline yourself to use only one or two credit cards. Any new charges must be paid off in full every month. Do not incur any more long-term debt.

Step 2 - Up the ante

Come up with $150 to $200 extra per month. If you have a good financial education and understand how to have money work for you, this should be relatively easy to do. If you can’t generate an additional $150 to $200 per month, then your chances for financial freedom may only be a pipe dream.

Step 3 - Focus on ONE credit card

Apply the additional $150 to $200 to your monthly payment on only one of your credit cards. You will now pay the minimum payment plus the extra money on that one credit card.

Pay only the minimum amount due on all other credit cards. Often people try to pay a little extra each month on all their cards, but those cards surprisingly never get paid off.

Step 4 - Keep it rolling

Once the first card is paid off, apply the total amount you were paying each month on that card to your next credit card. You are now paying the minimum amount due on the second card plus the total monthly payment you were paying on your first credit card.

Continue this process with all your credit cards and other consumer-credit debt. With each debt you pay off, apply the full amount you were paying on that debt to the minimum payment of your next debt. As you pay off each debt, the monthly amount you are paying on the next debt will escalate.

Step 5 - Go big

Once all your credit cards and other consumer debt are paid off, continue the procedure with your car and house payments. If you follow this procedure, you will be amazed at the shortened amount of time it takes for you to be completely debt-free. Most people can be debt-free within five-to-seven years.

Step 6 - Go big

Now that you are completely debt-free, take the monthly amount you were paying on your last debt, and put that money toward investments. Build your asset column, even using good debt.

How will you get out of debt?

Contrary to popular belief, debt is not something to be afraid of. Rather, it is a powerful tool to build wealth, when used correctly. Rich dad explained to me that our currency isn't an instrument of equity but instead an instrument of debt. Every dollar used to be backed by gold or silver. Today, every dollar is an IOU guaranteed to be paid by the taxpayers of the issuing country.

Even when Kim and I were almost $1 million dollars in the hole, we stayed with the preceding six steps and eventually got out of debt. It wasn't easy, but it was simple. The process required a lot of sacrifice at first, but following the simple six-step outline paved the way for the past two decades of financial freedom.

Now it's your turn. Get started today on your path to paying off your bad debt and invest in your financial education so that, when ready, you can harness the power of good debt to grow rich.

Original publish date: January 07, 2014

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