Debt Reduction
You really need to put all of the money you can into savings and retirement first and then pay off your debt as you can, right? Wrong! It is much better to pay off debt first, even if it means reducing what you put into savings or putting nothing into savings for a period of time. Why? Take a look at the interest rate you pay on your credit cards. If you are lucky you pay less than 18% APR. Look at what the bank gives you in interest on your checking and savings accounts or what the APR is on a one year CD. Chances are good that it will be less than the interest you are being charged on debt. If you put $100 into savings that earns 5% APR, then pay another $100 on a credit card that charges you 12% APR, you are losing 7% on your money. If you put the $100 toward the credit card debt instead, you will pay the card off early, then any savings you have will truly earn you the 5% because you won't have to offset your interest income with interest expense.
Most of us have some credit cards and perhaps a personal loan or two. Credit card debt alone has risen significantly over the last two decades as we have gotten into the unfortunate habit of buying now and paying later. The problem comes when you can't pay later, your debt rises, and you end up spending a small fortune in interest.
Being credit card debt-free at the least and totally debt-free at the most will save you thousands of dollars in interest over your lifetime. Consider going on a cash basis and putting the credit cards in a drawer.
If you are not in a position of paying off all your credit card balances in full each month, consider the following steps to reduce your debt.
Step 1: Write down all outstanding credit card and loan balances in ascending order (smallest to largest).
Step 2: Concentrate on completely paying off the card with the highest interest rate. For example, if the minimum monthly payment is $20 on the highest interest card, you could add an extra $50 to your payment and send a check for $70. Pay this extra amount every month until the entire balance of the highest interest credit card or loan is paid off.
Step 3: Once your highest interest debt is paid, concentrate on the second highest interest rate debt. Add the amount you were paying on the first debt (that is now paid off) to the minimum monthly payment of the second highest interest rate debt. For example, if the payment on the first debt was $70 and the minimum payment for the second card is $55, then your monthly payment to the second debt would increase to $125 ($70+$55=$125). The beauty of this system is that no additional money is needed. You were already paying the $70 anyway, now you are simply adding it to the next debt to pay it of faster.
Step 4: Repeat Step 3 as needed until your debt is paid off. The amount you are able to pay on each subsequent debt item will increase as you cumulatively add the payments you were making on the previous debt to the payment on the current debt.
Going One Step Further
Some people continue this plan beyond credit cards and personal loans and apply the money they were using to pay off credit card and loans to their car payments and their mortgage payments. If your credit cards and personal loans are paid and you choose this path, I highly recommend you do the following before you start: take the amount of money you were paying on your debt for one month and blow it on something fun as a reward! Then start on the mortgage and the car loans.
Once you get your debt reduced, the last thing you’ll want to do is start charging or getting personal loans again. Consider keeping your credit cards at home so you can’t impulsively charge something while you are out. Write checks or use your ATM (debit) card for purchases. If you need to, cash a check for the amount of weekly spending money in your budget each week and, when the money is gone, don’t buy anything until the following week.
If your debt is out of hand and you are unable to meet even the minimum payments on all of your debt, consider getting some help.
The National Foundation for Consumer Credit offers counseling and debt consolidation services. If these two resources don’t have what you need, check your local yellow pages for consumer credit agencies in your area. One warning—do not pick an agency that charges a lot of money. Most reputable ones have free counseling and free or very low-cost debt consolidation services.