The skillful use of credit gives us the ability to leverage our income and buy goods and services too big to fit within our monthly budgets. The skillful use of credit also entails periods when debt reduction is important, especially if our debt load has been elevated by unexpected events. With common sense, discipline, and familiarity with some basic tools, do-it-yourself debt reduction is an inexpensive alternative to paying fees to debt counselors and debt consolidation lenders. Here are a few guidelines to consider:
Develop A Clear and Objective Picture of Your Debt Load and Debt Reduction Goals
It often happens that our arrival at the point where debt reduction becomes a priority has been driven more by unexpected events and emergencies than by careful preplanning. An important starting point is to develop a clear and objective understanding of what we’ve got for debt today, and where we want to be at a future date. Here is an approach to starting that process:
- Order a fresh copy of your credit report. Review it for inaccuracies or evidence of fraudulent use, and make note of any recent negative entries. If you are married, be sure to have your spouse obtain a copy of their credit report as well.
- Assemble all loan documents, including installment loan contracts, credit card statements, student loans, and recent payday loan agreements if you have made any.
- Open a spreadsheet or use a clean sheet of paper to create a table listing each debt by type, outstanding balance, interest rate, minimum monthly payment, credit limit (where applicable), and space for comments on special circumstances regarding the loan.
- Use the comments column to identify loans with high interest rates, high balances relative to credit limits, or that have been the source of negative comments on your credit report.
Review Your Monthly Household Budget or Spending Pattern
Not all of us have developed formal household budgets, but if you have, check to make sure it is still reflective of your current circumstances. If you don’t maintain a monthly budget, make a fresh list of typical monthly expenses such as:
- Utility bills;
- Rent or mortgage;
- Insurance policies;
- Groceries;
- Minimum debt payments;
- Discretionary expenses such as dining out and entertainment;
- At least some allocation for savings.
Compare your list of expenses with your monthly income to determine the amount available for debt reduction.
Establish Your Priorities and Make a Plan
Use the table of debts established earlier to identify those debts which should receive the most concentrated attention. Usually these will be credit cards with high interest rates or balances close to their credit limit. Make sure your plan includes building up a savings fund to protect you against missing payment due dates when unexpected events occur. Set a goal for where you want your debt load and monthly debt payments to be at a specific date in the future. Picture your goal is realistic, and remember that elimination of all debts may not be practical, or even desirable from the perspective of your credit score. If your monthly expenses do not allow sufficient debt reduction funds to accomplish your debt reduction goal, you may wish to consider a debt consolidation loan. Debt consolidation loans can be helpful in several ways providing they are available at acceptable terms. Some of these ways include:
- Paying down the balances on high interest credit cards;
- Lowering your total monthly debt obligation by extending payment terms on some of your debts. Total monthly debt obligations should not exceed 35% of monthly gross income;
- Restructuring debts so that outstanding balances are low relative to credit limits. This will both improve your credit score, and sure that low cost credit is available when it is next to needed;
- Ensuring that sufficient funds are available for savings;
Talk to Your Creditors
Before putting a plan and action it may be worthwhile to contact your creditors, especially credit card companies, to see if they can offer you a lower interest rate or forgiveness of late payment penalties that have added to your outstanding balance. It is sometimes clearly in the credit card company’s interest to accommodate such requests, but you won’t get those accommodations if you don’t ask for them.
Final Thoughts
A debt reduction plan that is too aggressive can end up doing more harm than good. Keep these thoughts in mind during your planning process:
- Make the establishment of an adequate “rainy day fund” a priority in your planning process – even if doing so means pushing back the date at which you achieve your debt reduction goal.
- Double check your budget or anticipated monthly expenses. A budget which is too tight can erode the discipline necessary to stay on track, and increases the odds of future negative events that damage your credit score.
- Avoid missing payments by setting up automatic bill paying arrangements with your bank, and by setting up a system of due date reminders for debts that may have variable monthly payment amounts.
- Periodically update your budget assumptions and table of outstanding debts. Circumstances change over time, and may provide opportunities to save money and time by adjusting your debt reduction plan and goals.