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Keep Your Eye on the Prize
Everyone has goals that hinge on money. They want to add an addition to the house, or take a vacation, or put their children through college. Your goal should be to get out of debt or at least reduce it to a specific, manageable level. Once you have accomplished that basic goal, you can use all the extra money you’ll have each month to reach other financial goals.
If you try to accomplish too many goals at once (pay off credit cards, save for children’s education, buy a new car), you’ll probably find yourself reaching none of them. While your goal is to get out of debt, you can also set smaller, more immediate goals that you can celebrate as you reach them. Paying off one credit card is a good example. Or keeping track of your spending for one month is another.
In terms of getting out of debt, you’re going to have to decide how little debt you want to carry. Some people don’t mind if they have a car payment or student loan payments; they will be content if they can just pay off their credit cards. Others despise monthly bills and want to pay off all their loans except their mortgage. Still others don’t want to owe anyone a penny.
You should definitely try to pay off your credit cards, especially the high-rate ones, your car loan (since you are financing a depreciating asset), and any other installment loans that aren’t used for investment purposes. After working my way out of debt, my personal view is that the less debt you have, the better. Period. Even the supposed advantages of having a mortgage are overrated, despite the fact that you may be able to deduct some of the interest.
The lower your debt, the more money you’ll have for whatever you want to spend it on, and the healthier you’ll be financially.
A payback plan for your debts is where the rubber meets the road. Don’t even consider trying to just blindly pay back your debt as you go along. You’ll need a very clear plan, one that will show you how much you’ll pay, and ultimately how much you’ll save.
Create a list of all your bills, balances, minimum payments, and interest rates. With that information on hand, contact all your issuers to find out if you can lower your interest rates.
Be your own personal trainer and tailor your payback program to your own personal style. Although the biggest savings will come by getting rid of your most expensive debts first, that approach may not work best for you. Consider your options carefully, and choose the one you feel you can stick with:
Maximum Savings: With this plan, you pay just the minimums on all your debts—except the one that carries the highest interest rate. You throw as much money as possible toward that debt to get rid of it as quickly as you can. Once that balance is wiped out, you start on the next one.
This method—paying your highest-rate cards first—is going to save you the most time and money in the long run.
This method for paying off your bills is very powerful. With credit cards, you usually have a minimum payment that’s based on a percentage of how much you owe. So when you make a payment, the next month’s minimum payment is smaller. That stretches out your debt for years. When you instead start committing a fixed amount to paying off your debts, you beat the bank at its own game and speed up the time it will take you to pay off your balance—often dramatically.
There are two secrets to this method: First, commit a fixed amount toward your loan payments each month until they are all paid off. Say the first month your payments total $250, including the extra money you’ve decided to put toward paying them off. You want to pay a total of $250 every month until they are all paid off. If you have some extra money to throw at them one month, go for it. You’ll just pay them off a little faster.
Second, stop charging! If you have to use a credit card for emergencies or whatever, keep one card separate and try to pay it off as soon as possible. If you start charging on the cards you’re trying to pay off, you’ll find yourself digging the hole deeper.
Quick Results: If you’d like to see some fast results, don’t worry about the interest rates—you’re better off just getting rid of a bill as soon as you can. Choose your smallest bill and go at it with a vengeance, putting all the money you can toward it until it is paid off. Then go on to the next smallest balance, and so on.
Of course, both of these approaches assume you’ll do everything you can to stop taking on new debt. You simply can’t shed debt if you keep charging.
Starting Over: Sometimes the debt load is so high that there is no other choice but to file for bankruptcy and start over. On the one hand, bankruptcy isn’t the easy fresh start some attorneys would lead you to believe, but on the other hand, it is necessary for many people who are overwhelmed by debts.
The key to sticking to your debt diet is to remain flexible. If you need a new suit for an important job interview but your clothing budget is used up, consider “borrowing” from your recreation budget. Just don’t borrow from your loan payments budget. You don’t want to get back into the habit of juggling bills again.
If you find that you set unrealistic spending limits in the beginning, revise your spending plan the next month. Don’t be surprised if it takes several months of adjustment before your spending categories work realistically.
If you have money left over in one category at the end of the month, roll it over to the next month to create a cushion in case a large expense pops up later in that category. And if you do overspend a little (or a lot) one month, don’t give up on the whole program. One piece of cake doesn’t break a diet, and a few little slips shouldn’t ruin your debt diet either.
For many of us, getting out of debt is a marathon, and sticking with it can be long and difficult. You’re going to hit plateaus, and emergencies that challenge your plan will crop up. It’s important that you find encouragement along the way. Is there a trusted friend or relative who can cheer you along? If you are married, are you and your spouse on the same page?
The financial muscle you build while digging your way out of debt will serve you well. Although the training is tough, once the bills are paid off, you’ll be in great shape to achieve your goals and build wealth.