Tuesday, March 16, 2010

How to Eliminate Your Debt

If your goal is to pay off your debt, the first step is to stop using any form of revolving credit. (Revolving credit is a loan that you can borrow against, pay off, then re-use. Credit cards and some home equity lines of credit are examples of revolving credit.) Whether or not you have a balance on the card, stop using it.

The second step is to establish a set amount that you pay on your debt every month. If you “chase the minimum”, if you pay only what you have to every month, it will take years to pay it off. If you have three credit cards with balances (that you don’t pay off each month), you may decide to pay the first one $100 each month, the second one $200, and the third one $300. This means that you have dedicated $600 a month to debt reduction.

After a few months of paying your set amounts, the minimum required payments will have decreased and you will have a choice about how much to pay each card.

Now, let’s get strategic. You can take one of two approaches. The emotional approach is to maximize the amount you pay towards the debt with the smallest balance. So of your $600, you’ll pay the minimum amounts on the two larger debts and send the rest of the $600 to the smallest. This will pay it off as quickly as possible. Once that debt is gone, take your $600, pay the minimum on the larger debt and send the rest of the $600 to the smaller. When that debt is gone, send $600 every month to your last remaining debt.

The advantage of this approach is maximum positive feedback as you see the smallest debt decreasing then disappearing.

The second approach is the numeric approach. Instead of choosing the smallest debt first, choose the one with the highest interest rate. Follow the above system, applying the maximum available funds to the debt with the highest interest rate.

The advantage of this approach is that you will be spending less on interest and hence be saving money. (Note that the interest rate is independent of your minimum payment; the interest rate can be found on your monthly bill.)

Whether you go for quicker gratification or for saving money, the key is to establish a set amount that you pay towards debt every month and stick with it.

Final hot tip: Actually, the most important thing to do is pay your bill on time every month. Late fees can exceed how much you sent as a payment, creating a “one step forward, two steps back” situation.

Becky Jensen holds an MBA in Finance and has been helping people manage their personal spending since 1989. She can be reached through her web site at www.2prosper.com.

1 comment:

  1. I have three active credit cards but I am able to manage it all well because I control my use for each one. I allocated each card for a certain purpose. For example, one is for paying utilities and mobile plans, the other is for groceries, clothing, and other basic needs; lastly, the third card which has the highest credit limit is for my travels. It is easier for me that way because the amount I credit on my two cards are already allotted in my monthly budget, so I am able to zero-in the balance each time. The third card I rarely use so I don’t have a problem with that either.

    Jaden Allred

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