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Your Simple Debt Reduction Plan
If you find yourself struggling to meet your monthly obligations, unable to pay off your credit card balance due each month, or are looking to build or improve your credit, then it might be time to seriously consider a debt reduction plan. Here are 6 tips to help get you started.
1) Evaluate Your Situation
The first thing that you need to do is establish exactly what your current situation is. Don't be intimidated by this task -- it's time to make a serious commitment to debt reduction, and an honest assessment of your situation is essential. Write down all of your debts, break them down by balance due, how much the monthly bill is, and how much your cost of interest is. Be sure to include any fees or non-interest costs associated with your debts (for example, annual fees on credit cards.) Including everything, even long-term debts like mortgages and student loans -- even if you don't tackle these now, it's good to get a full picture of your financial situation.
2) Determine Your Budget
Make a note of your net monthly income from all sources, then subtract your recurring expenses, from fixed payments like your mortgage or rent to fluctuating but regular costs like gas and groceries. The remainder is what you have available to reduce your debt. If possible, look at your expenditures and see if there is any way to free up some more money. Don't forget, the faster you pay off debt, the faster your bills come down as your cost of interest declines, so spending a little more now can make a big difference in how much you have left at the end of the month in the near term as well as long term.
3) Set Your Goal
It is not always possible -- and not always desirable -- to be 100% debt free. Credit is a responsibility but can be a great benefit to your overall financial situation if properly managed. Now that you have a detailed picture of your financial situation, you can set a goal to improve it via debt reduction.
Make your goal specific - to reduce your total debt, to reduce your payment, to reduce your cost of interest, etc. by a specific amount or to a specific target - so that you can see your progress as it is made. This makes a huge difference in how you feel about reaching the goal. Also, make your goal realistic, and give yourself a set time in which to accomplish the goal. That's a critical piece of every debt management strategy. If you need to, start with a small attainable goal with a short timeframe, just to get yourself in the mindset "I can do this."
4) Plan Your Strategy
It is best to start with the bill that has the highest cost of interest. Different from the interest rate, the cost of interest is the true cost that you are paying on a monthly basis for any given account. A $10,000 credit card balance with an 18% annual interest rate might have a payment of $250, but it cost at least $150 per month in interest.
By contrast, a $30,000 five-year car loan at 12% will cost around $650 a month, but the cost of interest is approximately the same as the lower balance, lower payment credit card! Figure out what each account is costing you in interest. Unless one or more of your accounts are in arrears, start with the one that has the highest cost of interest. The reason for this is that the rolling interest costs are part of your monthly bills whether you feel them or not -- reducing them reduces your monthly dues and improves your financial situation proportionately.
If you have two or more bills with the same or very nearly same cost of interest, start with the one that has the lower balance. This is not necessarily the best financial strategy, but the psychological benefits of having "one less bill to pay" can make a real difference. There is a sense of accomplishment that comes with each stage of debt reduction.
Long term, typically low interest debts such as mortgages and student loans are generally not as important to pay off. But there are strategies that you can use to get these down too, if you want to really push the debt reduction envelope. We're going to put a handy mortgage calculator and other tools on DebtandCreditTips.com to help work out a mortgage reduction strategy.
5) Work Your Plan
Once you get started, don't let anything get in your way or discourage you! You have a duty to yourself and your family to get your debt under control and build or rebuild a strong credit rating and secure financial future. Indulgences that you might have to give up temporarily will still be there once you are done. Make every penny you can spare go towards achieving your debt reduction goal.
6) Follow Through
What to do once you've gotten part of the way there? If you pay off one bill, here's a suggestion: whatever the monthly payment was, divide it by three. Apply one third of the amount to further debt reduction, one third to savings, and just leave a third in the bank to ease up some of your monthly bill pressure or even to treat yourself.
If you have $300 to apply to debt reduction each month, and pay off a bill with a $150 monthly payment, you now have $350 a month to start on the next one! Plus $50 a month going into savings (and make that real savings, not something to tap out at Christmas) and $50 a month to treat yourself, or just to have a little extra cash. This is purely optional of course, and your own situation will differ, but each bill paid is making the next one easier to pay, plus building your secure savings, and allowing your debit card a little more breathing room as the surplus cash starts to add up.
All that's left now is: get started! There is no reason to procrastinate on crafting a debt reduction strategy. Do it today and get started implementing your plan as soon as possible -- the difference you make in your life will amaze you!