In this step, we’re going to do most of the preparatory work for your journey out of debt. This mostly involves preparing a budget and sticking to it, but we’re going to go into a little more detail than that.
We’re going to do three things.
- Draw up a monthly budget that’s sustainable over the longer term
- Calculate how long it will take to work your way out of debt given the budget you’ve chosen
- Choose the methods you’ll use to track your progress and stick to your budget over the duration of your journey
You should have your minimalist budget that you prepared during the first step nearby as you’ll need to refer to it.
Let’s get started.
Preparing The Budget
You now need to prepare a full budget that you can stick to every month. There are a few principles that we need to apply when we do this, and I have a budget tool that you can use to make sure you don’t miss any important categories out when you prepare it.
Please read through this section before you start.
- You’re going to start with the numbers you prepared last time. You will then add to those items the additional things you need to make the budget something you can stick to for the duration.
- You need to always be aware of the trade-off. The tighter your budget, the harder it is to stick to, but the faster you pay off your debts. The less restrictive your budget, the easier it is to stick to, but the longer it takes you to pay back your debts. You need to find the sweet spot where you make progress fast enough to stay motivated, but you don’t create a budget so constraining you give up in frustration.
- Large one-off costs, such as trips, school fees and gifts, should be saved up for every month. Use a spreadsheet, an envelope system, a separate bank account, whatever works for you. Just do your best to spread out those costs over the year rather than spend them all at once.
- Bear in mind that the budget is an iterative process. That means that you do it once, then go through it over and over again to gradually get to where you want it to be. You’ll also adjust it after you’ve started because you’ll learn from experience that certain limits are too tight, and that there are areas where you are able to save more.
- Remember the 80/20 rule. 80% of the results will come from 20% of the effort. Try to focus your efforts on savings or efforts that make the most difference to the bottom line. Avoid spending time on things that are “cool hacks” that don’t actually have all that much impact on your finances.
Building the Budget
Use whatever printable or budget template you want.
You will also need:
- The budget you developed in step 1
- An exhaustive list of every possible budget category
- Your bank statements or some record of past expenditure
If you want to use my comprehensive budget tool, it has certain advantages: It saves your budget so you can return to it later, it creates a printable format at the end, along with a few little bits of analysis, and it contains an exhaustive list of categories to help you cover every possible expense.
Here’s the process you follow:
- Fill in your budget template with the numbers from the minimal budget you created in Step 1
- Go through the categories and add recurring contractual spend that you currently have. Make a separate list of each of these contracts.
- Go through your bank statements and figure out how much you spend in each category. Estimate what a reasonable amount is in each of these categories and put that in your budget.
- Leave out any expenditure that is a luxury or a perk. You’re cutting these out of your life for now. Cigarettes, take-away coffee, expensive work meals. These little amounts add up and will create space in your budget.
- Once you’ve considered all your historical expenditure, put in amounts that you need to set aside to be able to pay for things like trips, school fees or other one-off costs.
- Go back through the budget, adjusting costs downwards where you think you can do better.
Once you have the budget, you need to calculate the amount of free cash this creates. If you used my tool, it works it out for you. That’s the amount of money you are able to contribute to paying off your debts every month.
This is not the end of the budgeting process, but you can stop for now. You can always come back to it later as you find ways to optimize it, or things you forgot crop up unexpectedly. The more accurate it is, the better.
Working Out Your Debt Repayment Plan
You now need to calculate how long it will take you to pay off your debts using the free cash amount you calculated above.
Once again, I have a tool that can help, but it’s not the only tool out there so feel free to use something else. You can find mine here :
Alternatives exist, such as this one, which do much the same thing.
The result is a spreadsheet that explains how your debts decrease, when each is paid off, and how long that will take.
This is your roadmap. It’s the time it will take you to fill the debt hole.
Now you can make some more informed decisions, based on this information and what you know of your own character and motivation.
If it doesn’t take too long, but you’re making a terrible effort each month, perhaps it’s better to relax your budget slightly and spread the pain out a little. On the other hand, if you’re unsure of your ability to stay on track for that long, it might be better to revisit the budget and increase the amount you can contribute to debt repayment each month.
Faster is always better from a pure financial standpoint, but from a human and psychological point of view, you need a plan you can work with.
Tracking Progress, Staying On Target
Now you know how fast you can go, and where you’re going. You need the tools that make it possible to stay the course.
The most brutal and effective method of all is the envelope system. For each budget category, put the amount for the month in an envelope and limit yourself to spending what is in that envelope. It’s impossible to cheat because you leave your bank cards in your wallet and only ever pay for anything with cash.
At the end of the month, anything left in the envelopes either goes to pay down your debt even faster, or to making the next month slightly more comfortable.
You can also use spreadsheets, printables or anythign that works for you. I wrote an article on a Spend Monitoring System some time ago that may be helpful.
Over time, you should apply every trick in the book to save more money, always focusing on efforts that actually make a difference. There’s a wealth of information avaialble in the financial independence and frugal living community and you can find my articles on this subject in the appropriate category : Spend Less.
You need to build a system that keeps you constantly aware of whether you’re on track or not.
Getting More Information
If you want more in-depth information on budgeting, I have a free email course you may want to enrol for. There’s no obligation and it just contains information and tools that help to understand the budgeting process and how it can be made as helpful as possible.
Sign up here : How To Budget
For saving money, living well within your means and finding pleasure in minimalism and frugality, browse the blog or sign up for updates – it’s the general theme of my website and I’m always adding new content.