In this article, you will be able to follow along at your own pace as you work to bury the debt monster and regain complete financial control. Whether you were like a child in a candy store or you simply spent a little more than you made every month over a long period of time, your debt can be crippling - and effect all other aspects of your life.
Opening Your Eyes
Many people don’t know how much debt they have, and whether or not they have a good balance of “good” and “bad” debts. Most people who have the most debt try to ignore the extent of debt they are in- in other words, they avoid reality because what you don’t know doesn’t hurt you, right? In this case, unfortunately, debt always hurts you over the long term.
Make a List
Let’s start with the “bad debts”, since these are the ones we will want to pay off as soon as possible. Bad debts include store credit cards, car loans, and charge cards- any purchase that loses value instead of offering you potential earnings.
On a piece of paper or on a computer spreadsheet, set up your list bad debt.
Next, do the same thing for good debts. Good debts are things like school loans, mortgages, second mortgages, and other investments that may earn money. Now, let’s take inventory of everything you owe on two separate lists: “bad” and “good”.
Analyze Debt to Income Ratio
Once you have both your lists completed, you’ll want to analyze the amount of bad debt you have. Get a total amount of the “amount owed” column of your bad debt list and compare it to your annual after-tax income. The bad debt total should not be a large chunk of your income. You can find your debt to income ratio (and we’re just dealing with bad debt at this time) with a simple formula:
If you’re total bad debt is $5,770 and your after-tax income is 36,000, you would have a bad-debt-to-income ratio of 16%. The goal is 15% or less in order to keep your payments manageable.
How Much You Actually Flush Down the Drain
Now, for a real eye opener, add up the amount of estimated interest you pay annually on your bad debt accounts. While student loans or mortgages are considered debt worth paying interest for, look at how much money you are flushing down the drain each year on your credit card and car loan payments. Think about what you could do with that extra money on an annual basis.
Lesson one has probably been an eye opening experience overall for the majority of you. The first step for alcoholics and drug addicts is to admit they have a problem- the first step for people looking to get out of debt is to face the debt monster and see exactly how much money they owe. The next lesson will lay the foundation for eliminating the worst of our debts:
Credit Card Debt Elimination
Now that you’ve taken inventory of all the debt you currently have, it’s time to do something about the amount of bad debt you have. You probably had some fun getting into debt, and took your time building that massive portfolio of outstanding accounts; unfortunately, getting out of debt isn’t as enjoyable! You will however, start feeling an enormous weight lifting off your shoulders as you start creating a plan to take over the debt monster once and for all- so let’s get started.
Pull out your “bad” debt list. It’s time to play with the credit card companies.
One by one, call each of your credit card issuers and try to get them to lower your interest payment. People who have a track record of making their payments on time in the past will have a higher success rate at this task, but it never hurts to try and you may be surprised at how much you can save just by asking.
Here is what you could say when you call your credit card accounts:
You: I just received a credit card offer in the mail that says I could transfer my balances for 5% interest. Your service has been really good and I don’t want to switch credit cards, but even though I’ve been using this card for 4 years, I’m still paying 18% interest. I’m really going to have to switch cards to save some money unless you decide to lower my interest rate.
Credit card company will give you some mumbo jumbo about your rate being the going rate, and maybe put you on hold for awhile as they check over your payment history. When they’re ready to talk to you again, you could follow up with something like this:
You: It may be a reasonable rate, or 18% may be the going rate, but since this other credit card is offering me 5.9%, I’m going to pay a whole lot less by transferring my balance to them. I need you to reduce my interest rate to at least 10%.
The credit card company will probably put you on hold while the representative checks with their supervisor or whoever is in charge in the mysterious and mystical world of credit card companies, behind the scenes. They just may come back and say they can lower it to 12% or some other number that’s higher than you requested but lower than what you had been paying. Accept the new rate and celebrate (but don’t spend very much on your celebration or you’ve wasted your time.)
Developing Your Plan of Attack
You can’t expect to bury the debt monster without a solid debt consolidation plan as it’s a very strong creature that steals from the Terminator’s famous line, “I’ll be back”; and back the debt will definitely be if you don’t have a plan.
On a new sheet of paper or in a new spreadsheet, rewrite the list so that the accounts that have the highest interest rate are on the top of the list, with the lower interest accounts at the bottom. This is the order in which the accounts should be paid off, generally. The reason why it is better to pay off higher interest accounts first is because less of your payment is going towards the principal amount owed.
Create Your Budget
You knew at some point we’d have to use the “B” word. That dreaded word that rhymes with “fudge-it”. Unfortunately, in order for you to successfully bury the debt monster and regain (or create!) financial independence, it’s necessary that you don’t fudge your budget.
Budget’s have gotten a bad rep because some people make them more complicated than they need to be, but there’s no reason to lie here: having to account for your money is no where near as fun as spending it on anything whenever you want. You just have to decide if you are committed to eliminating debt or if you’re going to let the “b” word scare you off.
When creating your first budget, or one that you are dedicated to live within, the first thing you’ll want to figure out is how much money you have each month after you pay all the necessary, monthly expenses.
Create a new list. This time, you’ll want to make a list of your monthly expenses. Include everything from your car payments to your rent or mortgage payments to utility bills and food. Some bills may only come every three months, and some bills may not be exactly the same each month, but make your list with monthly amounts by figuring out how much each bill is on a monthly basis. If your car insurance is paid every three months, just divide the amount of your payment by 3 in order to get the amount you would pay monthly. If your electricity bill fluctuates throughout the year, figure out the total amount you pay annually, and then average it over 12 months to figure out your monthly average bill- and pad the payment by a few dollars just to be sure.
Add up the total of all of your monthly expenses to get your total “must pay each month” figure.
Above it, write down your total income. For simplicity sake, just write down your income that you actually receive, and don’t worry about what is taken out for insurance or taxes or any of that. If you’re married, combine your after-tax income with your spouses to get a total monthly income.
Subtract your total monthly expenses from your total income. This is the amount you have left over each month (hopefully it is a positive number!) after you’ve paid all of the necessities, and it is called “discretionary income”.
Discretionary doesn’t really mean discretionary though! This “leftover” money is what you use for expenses that don’t really come out of your income monthly, like vacations, clothing, automobile or home repairs, gifts, etc. It’s also where you get the money for your savings account.
If you find that you have no money left over at the end of each month, or that you make less than you must pay out monthly, you need to make some adjustments. You may have to cancel the cable television bill, or get another job for a while until things are improved. If you don’t take steps to remedy this situation, you will not have any hope of making more money than you spend and therefore, no hope to eliminating the debt monster.
On the other hand, if you have a positive number of discretionary income, you can then multiply that number by 12 to get your annual discretionary income. With this number, you can divide up this money into the “odds and ends” that must be paid for, from entertainment to cable tv, to car repairs and holiday shopping.