Debt Reduction 101 – A Beginner’s Guide To Debt Reduction
Calculate How Much Money You Have On Hand
Checking Account:_______________
Savings Account:_______________
Wallet:_______________
Piggy Bank:_______________
Etc:_______________
(Exclude Retirement Accounts)
Total On Hand:_______________
Establish An Emergency Fund Minimum Amount
An emergency fund is your line of defense against the unplanned expenses of life. Many popular authors and commentators suggest a minimum Emergency Fund amount of $1000. Others suggest $500 per family member. Establish an amount with which you are comfortable, and keep that amount of money in your savings, at all times, throughout your debt reduction process.
Emergency Fund:_______________
Calculate How Much You Have Available For Immediate Debt Reduction
Total On Hand – Emergency Fund = Available For Debt Reduction:_______________
If the calculation above results in a negative number, you need to build your emergency fund before you begin to reduce your debts. Continue to make minimum payments to your creditors, and focus on building your emergency fund. Once your emergency fund has been established, move forward with your debt reduction process.
If the calculation above results in a positive number, you have money available for immediate debt reduction. Congratulations.
Create A List Of Your Creditors (Balances, Interest Rates, Minimum Payments)
Credit Card 1:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Credit Card 2:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Credit Card 3:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Automobile 1:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Automobile 2:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Student Loan:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Other Debt:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
(Include or exclude first mortgage debt)
Calculate Total Amount Of All Debts
Total Debt Balance:_______________
Decide Which Debt Reduction Method Works Best For You
There are several popular debt reduction methods, but they all work on the same principle – momentum. Imagine that, instead of several small debts, you have one big debt, which you just calculated. Your goal is to eliminate your Total Debt Balance. To do this, you need to have a plan in place, a plan that works for you. Remember, you goal is to eliminate all of your debt, not just a balance here or a balance there.
If you want to ensure that you pay, over time, the smallest amount of interest, then reorder you list of creditors by interest rates. Put the creditor with the highest interest rate on top, the creditor with the next-highest interest rate second, and so forth. Over the long run, this method, if followed correctly, will be the most mathematically sound.
If you want give yourself the emotional boost that comes from quickly eliminating a creditor or two from you list, then reorder your list of creditors by account balance. Put the creditor with the lowest balance on the top, the creditor with the next-lowest balance second, and so forth. Over the long run, this method, if followed correctly, will cost a bit more than the previous method, but watching those first two or three creditors disappear can be very rewarding, psychologically and emotionally. This is the method that I used when getting out of debt in 10 months.
If you want to eliminate creditors based on how much they bother you, regardless of balance or interest rate, reorder you list of creditors using your very on this-debt-bothers-me scale. Put the creditor that bothers you the most on top, the creditor that bothers you just a little less second, and so forth. This method works best for those who owe debts to the IRS or family members, and just want to see those debts gone!
If you are behind on a particular account, by all means, move it to the top of the list.
List Your Creditors Based On Your Selected Debt Reduction Method
Credit Card 1:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Automobile 1:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Student Loan:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Credit Card 2:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Other Debt:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Credit Card 3:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Automobile 2:__________Â Â Â Â Interest Rate:__________Â Â Â Â Minimum Payment:__________
Begin To Live On A Budget
I added this section after publishing this guide. If you are not living on a budget, start now. I’ve written extensively about this subject, including the following articles: How To Create A Budget With Irregular Income, 10 Ideas For Creating A Better Budget, and Creating A Basic Budget. Needless to say, which is why I left this part out of the guide at first, if you are not living on a budget, you cannot get out of debt.
Stop Using Credit Cards And Accumulating Debt
Again, after publishing this guide, I felt the need to go back and add this section. If you are trying to get out of debt, the last thing your need to do is borrow money. Stop using your credit cards and start paying off your balances. If you absolutely must use a credit card while getting out of debt, something I strongly urge you not to do, please use a card that you can pay off, in full, at the end of the month.
Make Minimum Payments To All Creditors
Never miss a minimum payment and always make minimum payments on time. For credit cards, your minimum payment can be found on your monthly statement. For automobile loans and other installment, your minimum payment is your monthly payment.
Send Extra To The First Creditor On Your List
You have already calculated how much money you have on hand for immediate debt reduction. Send that amount to the first creditor on your list. If you have enough to completely pay off your first creditor, great! If you still have money left over after eliminating your first creditor, send that money to the next creditor on your list.
When sending extra payments, feel free to send one check, with your minimum payment plus extra payment, or, send two checks, one for the minimum and one for the extra payment (marked apply to principal). Contact your creditors and ask them how they handle extra payments / payments above the minimum. You do NOT want to prepay your automobile loan, for instance, you want to PAY DOWN your principal. Use online banking to eliminate postage.
Eliminate Creditors From Your List
Each month, continue to send minimum payments to all creditors and an extra payment to the creditor on the top of your list. Eventually, you will begin to eliminate creditors from your list, by paying off entire account balances. This is where the fun begins. Combine the minimums that were going to creditors no longer on your list, and apply those minimums, along with your extra payment, to the next creditor on your list. Continue this process of eliminating creditors, applying old minimums and the extra payment, until you are debt free!
If you want to speed up the process, consider sending more than one extra payment, each month, to the account at the top of your list. These micro-payments will keep you engaged, throughout the month, in the debt reduction process. Each daily financial decision, big or small, will impact how much extra you have for debt reduction. Sending a micro-payment of $10 will encourage you to skip the restaurant and brown-bag-it for lunch.
Additional Resources For Speeding Up Your Debt Reduction
Debt Reduction Guide – An easy-to-follow guide to debt reduction – complete with advanced tips and techniques.
Debt Reduction E-Book – An 8 page, free-to-download guide to debt reduction. PDF
Illustrated Guide To Debt Reduction – For those, like me, who are visual learners.
Illustrated Debt Snowball – Exactly how the debt reduction method works.
How I Got Out Of Debt – Want to read my story? Click here and follow the posts from start to finish.
This is by no means a citicizm of your reduction form, but I did notice two items that are missing. Debt reduction begins with understanding cash inflows and outflows. The difference between thetwo is the amount that is left for reducing debt. Without taking into account inflows and outflows to/from all all sources, no debt reduction plan would be complete, because, if there is no money left over from payments of fixed expenditures (food, utilities, gas, etc.) then the debt will not get reduced. In my personal experience, developing a budget and reducing eliminating costs is the first step, especially when attempting to take an aggressive approach to reducing debt. Once the budget is set and analyzed for all possible cuts in spending, then the reduction strategy should be undertaken. Again, this is just meant to enhance the effort to get out of debt, while gaining a new understanding of budgeting and planning.
This is a great article – one suggestion is to find an online calculator or software that could do the job. Doing is by hand is to painful.
Nice guide NCN.
I think changing one’s mindset to not to use debt, freezing or cutting up the cards, not using HELLOC, not getting cars loans is critical. If you don’t shutoff the water you can’t stop the leak.
What should one do when you can’t make the minimum payments? I have talked to the credit card companies and they won’t do anything until I can tell them when I can pay. My husband is commission only so I really can’t tell them. It’s turning into a nightmare for me. I am trying very hard not to worry over it.
What hurts most is that I was on a good plan for paying everything off. Had my spreadsheet and snowball going…then I lost my job. I can’t seem to get it back on track now that I am back to work.
Any advice?
Lovely advice. Also, don’t forget to make it a regular practice to call your credit cards to ask for a lower rate. I have one client who owes over $20,000 on a Visa that was at 18%. He spoke with a ‘rate specialist’, touting his rising credit score and declining balance and got his rate cut in half, from 18% to 9%! His monthly interest charge was instantly reduced by $150, which will help him pay off his debt even sooner. The method described above is the best way to get our of credit card debt, but you might as well make it even easier to see if you can lower those interest rates!
Glad you weren’t hurt or your daughter with the deer accident. Congrats!!!!!!!!!!!!! on your weight loss I’m rooting for you. I am now maintaining my weight and its challenging.
Love your articles keep them coming.
Jane 🙂
One thing I’ve got to stress, is just make sure you pay as much as you can to your debts with the highest interest. Sure it would look nice to eliminate some off the list if they have small balances, but it does not make sense financially. Interest rates can kill you if you let them.
Here’s a helpful calculator I found. it’s not quite debt reduction specific; it’s got investment options, too.
http://www.debthelp.com/calc/payorinvest.html