2torial #0692:
Learn2 Get Out of Debt

Lend yourself a helping hand

Do you toss and turn at night, thinking of the huge amount you owe your creditors--or even your mother? When bills come, do you throw them into a corner unopened, and eventually send them off with a check for the minimum balance? If so, you need to take control of your finances--before they take control of you.

The bad news is, no matter how hard you wish, your debts won't magically go away. The good news is, you can get out of the hole. And no matter how bad your credit is now, eventually it will be redeemable. So square your shoulders, pull out all of your bills, and read on. You're already on your way to financial freedom.

It's time to face all of the dark corners of your financial life. Drag that shoebox of receipts, bills, and loan agreements out of the closet and organize your records. Pull out your old checks, receipts, bank and credit card statements, and file them chronologically in separate files.

Perhaps most important, don't get discouraged by what seems like an enormous task. Remember that you're consolidating now so your financial life will be simpler in the future.

Calculate your total debt

Now that you've made the decision to face your debts, you need to assess just how much you owe. Sit down and make a list of everything, including credit cards, personal loans, auto loans, and student loans. Don't forget to include all your outstanding home and utility bills, and any money you might owe friends and family.

Now, make a worksheet showing these outstanding balances plus any interest rates or managerial fees that apply. You'll also want to separately list your assets, including all savings, property, and investments.

Next, you'll need to compare what you owe against your net monthly pay (after taxes). In a perfect world, your debt is considered manageable if the total (not including your mortgage) is less than 20 percent of your net pay. If your debt totals more than 20 percent, don't panic--that's why you're reading this 2torial.

Note: If your debt is 80 percent of your income or more, your financial situation is very serious. It's time to get a second job or, as a very last resort, consider filing for bankruptcy. It's important to realize, however, that bankruptcy stays on your credit record for ten years, so you should consider every option available to you before taking this drastic route.

Prioritize your debts

One good thing about debt management is that it's not rocket science. The bottom line is that you want to pay off the most expensive loans first. Once you've listed all of your debts, you can clearly see which ones cost the most. Which loans have the highest interest rate? Are there other fees in the fine print? For example, many credit cards with low interest rates have high annual fees or rates that go up after one year.

List your debts again, this time in the order you need to pay them. Put the bills you absolutely have to pay first, like your rent and telephone bill, at the top of the list. Next should be loans and credit cards with the highest interest rates. Put low-interest loans (such as student loans) at the end of your list.

Note: Although many people are hesitant to give up their savings, the best thing you can do for yourself financially is pay off your debts immediately. Unless you have an incredibly low interest rate on your loan or credit cards and have invested your savings in some high-yield avenues, the money you'll make from the interest on your savings will be less than the money you're losing in debt. Although you should set some money aside for emergencies (discussed later), it's ultimately a far better idea to pay off your credit than to squirrel your money into an account that won't be immediately beneficial.

Consolidate

If you have more than one credit card with an outstanding balance, it's time to consolidate. If one of your cards has a lower interest rate than the others, transfer the high interest balances to the lower interest card. By putting everything on the lower interest card, you'll cut out extra fees and save money on the interest you'd be paying by having more than one card--money you can put toward paying off your debt.

If you only have one card but it has a high interest rate, investigate cards with lower rates. Credit card companies have become extremely competitive, and there's no reason to pay a high interest rate when a lower one is available. Just be sure to read the fine print: A 2.9 percent interest rate might sound great, but not if there's an annual fee of $200. If you apply for a card with a lower rate and are accepted, transfer the balance from the high interest card onto the new card.

In either scenario, you should cancel your old cards as soon as you transfer the balance, so you're not tempted to use them again. In fact, you can even cancel the credit card that you keep the balance on before it's paid off, if you want to be absolutely sure you'll be free of credit temptation.

If you've maxed out so many cards that you can hear the bankers laughing at your credit application, it's time to research some low interest loans. Many banks offer personal loans called debt consolidation loans. Just be sure you're borrowing from a reputable institution (check with the Better Business Bureau to make sure), and that you read the fine print.

If you can, bank with a credit union, which will have loans at lower rates than ordinary banks. Many also offer free checking and savings accounts. To find out if there's a credit union in your area that you're eligible to join, contact your state’s credit union league (if you live in the U.S.).

Assess your spending habits

Most people with large debts have them because they tend to spend more than they make. Unless you're in debt because of an unfortunate situation (such as an accident or divorce), you probably need to rethink the way you spend money.

The best way to assess your spending habits is to make another worksheet. At the top, write down your total monthly income after taxes, including your monthly salary and any other source of income (like a second job). Subtract any fixed payments such as credit cards, loans, utilities (phone, water, gas, garbage, etc.), and mortgage or rent. Now it's time to see how much you spend on other things.

For one week, carry a notebook with you and write down everything you buy. At the week's end, look at your notes and make another worksheet, this one categorizing what you spent money on. Include groceries, clothes, movies, eating out, transportation, and anything else you spend.

Now, decide what you can live without. For instance, if you spend $50 (U.S.) per week on cabs, consider taking the bus. If you spend $7 a day on lunch during the week, it's time to bring sandwiches to work. Cutting out small, easy things can eventually add up to a lot of extra money, which you can use to pay off your debts.

However, keep your goals realistic. Allocate an affordable amount each month for an occasional "splurge" so you don't feel deprived. If you buy something fun or treat yourself to a meal with money you've set aside, you'll enjoy yourself twice as much.

Establish a payment plan

Take another look at your weekly expense worksheet (including fixed expenses) and multiply the total by four. This is what your monthly expenses are. When you subtract your expenses from your total income, you should have some money left over (if not, go back to Step 4 and cut out some more expenses).

Set aside about 15 percent of that surplus as a buffer of expense money for emergencies and months that you exceed your usual expenditures; put it into a savings account. What's left is a basic amount that you can use to establish a payment plan.

Use the money needed for your monthly expenses to pay things off, starting with allocating as much as possible to your high-interest loans and credit cards. Some banks will arrange for money to be transferred automatically on a certain day of each month; consider doing this so you won't have to worry about sending a check (and won't be tempted to skip a month).

If you weren't able to consolidate, make sure you keep up the minimum balance on all of your credit cards and loans while you pay more to your top priority. You don't want to get further in debt on one loan while digging yourself out of another.

Finally, when the credit card bill comes, pay as much over the minimum balance as you can. The less you pay each month, the more interest you'll accrue, keeping you in debt for longer and with a heftier bill to pay. Consult the chart below for a better idea:

Now that you've decided to get serious about paying off your debts, keep a note with the total amount you owe in a highly visible area, like on your computer or refrigerator. Each time you make a payment, update the note with the lower amount. You'll be inspired as you watch the amount decrease--especially on the happy day when it finally disappears.

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