One of the most crucial steps to getting out of debt is to begin budgeting. In addition to being simple, it is the most practical. Yet many who are buried in a mountain of debt ignore the obvious. The main goal of budgeting to get out of debt is to gain an element of control so that you spend less than you make. The leftover unspent portion of income can then be applied to get out of debt in the way of accelerated payments to creditors.
There are also some areas of budgeting that you might not have considered. Here are some critical elements that should be part of any budget with the aim of getting out of debt.
Collecting the information
Collecting the information for your budget involves listing all sources of income and every entity you have to pay on a monthly basis. For those with a fixed income, this step is relatively simple. The only thing to remember is to make sure you list income sources other than your regular paycheck. Look for things like tax refunds, annual bonuses, and stock dividend payments.
For those who are self-employed, determining monthly income is a little more complex. You need to estimate your annual income and divide by 12 in order to come up with your monthly income. Quarterly self-employment taxes need also to be taken under consideration.
A budget should be managed in a monthly context therefore any payments you receive sporadically throughout the year should be divided by 12 in order to get a true picture of your monthly income. An example of converting income to a monthly amount is when your paychecks are issued every 2 weeks. This is 26 pay periods annually and the total of all your paychecks should be divided by 12.
After listing your sources of income, the next step in collecting information is to list all your monthly expenses. Here again, you want to get the numbers in monthly terms. So, any expenses that you pay annually such as insurance premiums should be divided by 12. Personal finance software is a great tool to assist you in analyzing collected data.
The Analysis and Action
Once you have all income and expenses listed, the next step is to analyze the situation. In simple terms, if you have less coming in than going out then you have to take action to correct the situation.
Taking action comes in many forms such as finding additional sources of income, reducing expenses, getting rid of variable expenses, selling unwanted items, doing odd jobs, getting a second job, and a number of other ways. Taking action can also include more drastic measures such as debt consolidation or debt management plans. However, the latter should only be used as a last resort when you have run out of other options.
As mentioned in the previous list, one action that is a definite must is to try to get rid of all variable expenses. Variable expenses, as the name implies, are difficult to manage in a budget because of the way they change. A good example of variable expenses is utility bills. Heating, for example, will cost more in the summer and less in the winter. Your utility company can help you out by averaging your estimated bill for the year allowing you to make a fixed payment.
Getting rid of your debt is also crucial, so allot a space in your budget for debt repayment. Make sure to pay off your personal loans, your credit card debt, car loans and other outstanding debts. It makes it very difficult to build up your savings account if you still have debt.