Date Created: May 13, 2005, 10:03 AM
Our generation has become the credit card generation (or should I say debt card generation). Credit cards, lines of credit, un-secured loans... we've gained many benefits through the buying power and efficiency of these modes of transaction, but have also fallen prey to the sinister spectre of debt. $10,000+ of debt and 20+% interest rates are no longer unheard-of. If you are just paying the minimum due, it could take 30 years or more to bring that debt down to zero... and that's if you stop spending on that credit card (like that's even possible)! So how do we dig ourselves out of this never-ending cycle of "just-getting-by"?
Paying off your debt is one of THE most important principles in your future wealth. You can't have a good financial future without a good FICO score (mostly based on your debt to credit limit ratio), reduced debt, and a savings and investing plan. Debt reduction should be one of your top goals before saving and investing (with the exception of investing in your 401k if there is a company match... you never turn down FREE MONEY. Check my previous articles for more info). For instance, if you have a savings account that you're holding on to as an emergency fund or just so you'll have "some savings"... it'll on average have a 2% interest rate. Most debt accounts run between 6% and 30%... so lets say you have a 11% interest rate credit card. Your "savings" would be earning less each month than what you actually lose in the credit card's finance charge if you carry a balance. You might as well put that money where it'll do the most good for you before it bleeds your wallet dry, by helping reduce your debt. So while you have a large amount of debt, you should devote the money you earn to reducing it rather than pumping it into your savings account... only after you clean up your debt should you start socking away that "Emergency Fund".
Other than reducing your expenses and getting a raise, there are some really good techniques you can employ to get that debt monkey off your back. One of the best ways to reduce your debt is altenately called the Push Method or Snowballing your debt. This method involves paying the minimum on all accounts except for one which you'll do your best to pay off in full. What you should do first is to list down your various forms of active credit accounts (cards, car loans, etc.). I didn't add Student Loans to the list because interest on them is tax deductible and the relative interest should be low if you consolidated recently (you did consolidate them right... RIGHT??). Once you have your list of credit, you should write down next to each your current balance and the current interest rate of each account. Now re-order them with highest interest rate at the top (not the highest balance). This is the order you should pay off your loans. You'll pay the minimum payment (or double the minimum if you want to be "safe") in all your accounts except the one on top of the list. For that account you'll pay as much as you can possibly afford that month. After a few months (hopefully) and that account is payed off, you'll start paying off the next one on the list. The more accounts you close, the more money you'll have each month to pay off the next account. The reason you take on the higher interest rate accounts first is to reduce the amount of interest based finance charges you have to pay off and in effect lessens the time you'll need to pay off all your accounts.
Now each time you pay off your account, keep that account open. What ever you do, don't call your credit card company to cancel the card! Part of your FICO score and credit worthiness is the length of time your accounts have been active. The older your credit history, the better your credit profile. So if you close a card, especially one you've had for years and years, it drops off your credit report and you lose the credit history points you've earned by being a "good consumer". This can definitely adversely affect your credit rating... so keep those accounts open. If temptation is too strong after you've reduced the balance on your cards; just cut up the ones you don't want to use anymore (keep at least one for regular use) but keep the account open.
Followed diligently without additional large purchases, you'll be able to be relatively debt free quicker than you thought possible.
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