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. For example, if
you put $100 into savings that earns 5% APR (and if you find that rate these
days please let me know), 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 immediately save the 12% APR by paying on the
card, 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, or are only able to pay the minimum on some of your cards, 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) along with the interest rate
you are being charged for each one.
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, while you continue to pay the
minimum on the other debt.
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. Continuing the example, you would now take the $70
you were paying on the card that is now paid off and add it to the minimum
payment for the next card. If the minimum payment on the next card is $55, then
your monthly payment to the that card 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 some of the amount of money you were paying on
your debt for one month and reward yourself for getting your credit cards paid
off! 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 this does not help, 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.