In 2006, Oprah Winfrey collaborated with top financial experts Jean Chatzky, Glinda Bridgforth, and David Bach to present “Debt Diet,” a series focused on getting out of debt, on her show. These financial experts offered eight steps to help people gain financial freedom.
But what comes next? Financial health doesn't end once you're debt free. Read on for reasons why you should get out of debt now, a summary of the Debt Diet plan, and what to do next.
Why you should get out of debt
“If you don’t have any money, you should not buy anything,” Amy Poehler reads from a pamphlet entitled, “Don’t Buy Stuff You Cannot Afford,” in a 2006 Saturday Night Live sketch.
“Let’s say I don’t have enough money to buy something,” Steve Martin proposes. “Should I buy it anyway?”
“No,” says Chris Parnell.
Quite simply, when people in debt, they are spending money they don’t have. If you have significant credit card debt, you’re probably using a credit card with a high interest rate, meaning you’re also paying additional fees.
You’re borrowing against yourself; because you can’t afford to pay for what you need now, you’re borrowing from your future income. Once you earn that money, you’ll use it to pay off your debt and additional fees you’ve incurred, which will at best leave you with nothing, and at worst put you in even more debt.
Debt can impact many aspects of your life, not just your finances. Since your credit use ratio (essentially the amount you owe compared with your credit limit) accounts for 30 percent of your FICO score, debt may impact your ability to take out loans or buy a house, auto insurance, and other essential items. Some employers check your credit score and history as well, so it could impact your professional life, too.
The strain of being in severe debt can take a toll on your mental and physical health, as well as relationships. You may receive phone calls from debt collectors, third-party agencies businesses use to collect money owed to them, which can cause stress.
Oprah’s Debt Diet
The first step (or set of steps) to securing your financial health is getting out of debt. Here are the eight steps that comprise Oprah’s Debt Diet plan:
Phase 1: Short-term goals
Step 1: How much debt do you have?
You may not be aware of how much debt you’ve accrued. Track down all your bills and find out the interest rates on every credit card you carry to find out how much you really owe.
Next, find out your credit score. You can get one free credit report per year free each of three credit bureaus: Equifax, Experian, and Transunion. Set up an account at annualcreditreport.com to receive them. Many credit card companies allow you to track your credit score for free, so make sure you check with your lender.
Finally, prioritize your essential items. According to the plan, supporting yourself and your family comes first, government loans (including student loans) comes second, and everything else should be third.
Step 2: Track your spending and find extra money to pay down debt (find your latte factor®).
Coined by David Bach, this concept says that you should put $10 per day toward resolving your debt instead of spending it on things you don’t need, such as fancy coffee.
Step 3: Learn to play the credit card game.
Start by paying more than the minimum payment due on your credit card statements. That way, you’ll end with lower debt than you would if you just paid the minimum. Then contact credit card companies to try to get them to lower your interest rates. Name competitors with lower rates to use as leverage.
Learn the four tricks credit card companies use: interest rates, late fees, teaser offers (ads that use manipulative language and require you to read the fine print), and annual fees.
Finally, figure out which credit cards to pay off first based on your debt and interest rates.
Step 4: Stop spending.
This sounds deceptively simple, and it returns us to the “Don’t Buy Stuff You Can’t Afford” sketch. Limiting the temptation by using tricks such as carrying debit cards and cash instead of credit cards, turning down credit-line increases, and avoiding new credit card offers can go a long way in reducing your spending.
Phase 2: Longer-term goals
Step 5: Create a monthly spending plan.
Account for essential items, such as rent and groceries, and plan for special events. Do this monthly, 15 days before the new month starts. Then determine which bills you’ll pay with which paycheck.
Step 6: Take big steps to grow your income.
This will involve making tough choices. If the first five steps haven’t impacted your debt in a big way, you might need to take more drastic steps, such as moving or giving up your car. You might also need to sell off assets, getting valuable items appraised before you sell them. Additionally, you should try to grow your income by taking on additional part-time jobs to support you while you try to get out of debt or asking for a raise at work.
Step 7: Prioritize your debts and raise your credit score.
Learn the difference between secured debt—debt back by assets that can be repossessed—and unsecured debt—debts with no assets backing them. Satisfy your debts in this order:
• All secured debts
• Debts that can be taken from your paycheck.
• Service you need to keep using for your wellbeing.
• Unsecured debts, such as credit cards.
• Debts to family and friends.
Work on improving your credit score as well. Paying off your bills on time is a start. Check out this worksheet for more tips.
Step 8: Understand your spending issues and save.
Learning why spending is a problem for you can help you prevent it from happening again. Take Oprah’s self-assessment, consult a therapist, discuss the problem with friends and family members, or do some deep soul-searching to figure out what’s driving you to spend money you don’t have.
Then start working on your financial future.
A.D. (After Debt)
• Make a plan.
You got into debt for a reason, and you don’t want to end up there again. Use the reasons you came up with in the final step of Debt Diet as a basis for developing a plan and to-do list for managing your money. Your plan might involve goals (something for which you're saving, avoiding spending on non-essential items for a given period of time, etc.), thoughts on how much you'll pay beyond minimum payments for credit cards, managing other payments, how you'll track your spending, and steps you know you need to take to prevent you from ending up in the same place. You should also plan for how you’ll avoid known temptations and deal with experiences that pose a risk to your spending.
Your spending plan doesn’t end once you get out of debt. Continue to budget your expenses on a monthly basis, accounting for all necessities and events that may require you splurge. Decide how much you can afford to spend on each of these “splurges,” and make sure you factor in savings.
• Set up a savings account.
On that note, make sure you’re setting aside a portion of your paycheck for savings. Many financial advisors recommend that you allocate 20 percent for your savings account.
If you don’t have a savings account yet, set one up so you’ll start earning interest. Make sure to compare interest rates to maximize the amount of interest you’re earning.
There are many different ways to invest your money. If you do it carefully, you’ll be able to grow your wealth without getting in over your head. It’s best to start by getting some advice from a financial advisor or a friend or family member you can trust with financial matters.
Setting up a 401k is one low-risk form of investing. Many employers have matching 401k programs, meaning they will contribute the same amount of money to your retirement savings plan as you do, up to a certain percentage. You may have a choice as to how your 401k is invested. Keep in mind that in most cases, you won’t be able to withdraw funds from your 401k until you’re 59-1/2 without incurring a penalty. You’ll also generally have to work for your employer for a certain length of time (called vesting) before you can access your employers contributions.
You may also consider investing in the stock market, but again, be very careful with your investments and get advice for your personal situation before making this decision.
Once you’re debt free, you should also consider your future. How does spending factor into your goals and plans? Also, think about how you’ll do the activities you couldn’t do while you were in debt—without getting in over your head. Your plans should also account for how you’ll save money to help you realize your goals. Now you can, so live a little!