Nick writes with a common question:

I am a college student with $8,000 of debt. What is the first step in paying this off?

Debt elimination involves three steps:

  1. Stop acquiring new debt.
  2. Establish an emergency fund.
  3. Implement a debt snowball.

Here’s how to approach each step. (I’ll use Nick’s situation as an example, but the principles apply to everyone.)

Stop acquiring new debt

(This step can be accomplished in an afternoon.)

This may seem self-evident, but the reason your debt is out of control is that you keep adding to it. Stop using credit. Don’t finance anything. Cut up your credit cards.

That last one can be tough. Don’t make excuses. I don’t care that other personal finance sites say that you shouldn’t cut them up. Destroy them. Stop rationalizing that you need them.

  • You don’t need credit cards for a safety net.
  • You don’t need credit cards for convenience.
  • You don’t need credit cards for cash-back bonuses.

You don’t need credit cards at all. If you’re in debt, credit cards are a trap. They only put you deeper in debt. Later, when your debts are gone and your finances are under control, maybe then you can get a credit card. (I don’t carry a personal credit card. I don’t miss having one.)

After you destroy your cards, halt any recurring payments. If you have a gym membership, cancel it. If you automatically renew your World of Warcraft account, cancel it. Cancel anything that automatically charges your credit card. Stop using credit.

Once you’ve done this, call each credit card company in turn. Do not cancel your credit cards (except for those with a zero balance). Instead, ask for a better deal. Find an offer online and use it as a bargaining wedge. Your bank may not agree to match competing offers, but it probably will. It never hurts to ask.

Establish an emergency fund

(This step will probably take several months.)

For some, this is counter-intuitive. Why save before paying off debt? Because if you don’t save first, you’re not going to be able to cope with unexpected expenses. Do not tell yourself that you can keep a credit card for emergencies. Destroy your credit cards; save cash for emergencies.

How much should you save? Ideally, you’d save $1,000 to start. (College students may be able to get by with $500.) This money is for emergencies only. It is not for beer. It is not for shoes. It is not for a Playstation 3. It is to be used when your car dies, or when you break your arm in a touch football game.

Keep this money liquid, but not immediately accessible. Don’t tie your emergency fund to a debit card. Don’t sabotage your efforts by making it easy to spend the money on non-essentials. Consider opening a savings account at an online bank like ING or Emigrant. When an emergency arises, you can easily transfer the money to your regular checking account. It’ll be there when you need it, but you won’t be able to spend it spontaneously.

Implement a debt snowball

(This step may require several years.)

After you’ve stopped using credit, and after you’ve saved an emergency fund, then attack your existing debt. Attack it with vigor. Throw whatever you can at it.

Many people say to pay your high interest debts first. There’s no question that this makes the most sense mathematically. But if money were all about math, you wouldn’t have debt in the first place. Money is as much about emotion and psychology as it is about math.

There are at least two approaches to debt elimination. Psychologically, using a debt snowball offers big payoffs, payoffs that can spur you to further debt reduction. Here’s the short version:

  1. Order your debts from lowest balance to highest balance.
  2. Designate a certain amount of money to pay toward debts each month.
  3. Pay the minimum payment on all debts except for the one with the lowest balance.
  4. Throw every other penny at the debt with the lowest balance.
  5. When that debt is gone, do not alter the monthly amount used to pay debts, but throw all you can at the debt with the next-lowest balance.

I’m a huge fan of the debt snowball. It still takes time to pay off your debts, but you can see results almost immediately.

Supplementary solutions

You can do other things to improve your money situation while you’re working on these three steps.

First, focus on the fundamental personal finance equation: to pay off debt, or to save money, or to accumulate wealth, you must spend less than you earn.

Curb your spending. Re-learn frugal habits. (Frugality is something with which most college students are all too familiar.) You can find some great ideas in the archives of this site. Also check Frugal for Life.

While you work to spend less, do what you can to increase your income. If possible, sell some of the stuff you bought when you got into debt. Get an extra job. (But don’t neglect your studies for the sake of earning more. Your studies are most important.)

Finally, go to your local public library and borrow Dave Ramsey’s The Total Money Makeover. Don’t be put off by the title — this is a fantastic guide to getting out of debt and developing good money habits. I rave about it often, but that’s because it has done so much to help my own personal finances. After you’ve finished, return it and borrow another book about money.

The most important thing is to start now. Don’t start tomorrow. Don’t start next week. Start tackling your debt now. Your older self will thank you.