One of the most common financial goals is “I want to pay off my debt.” If you carry debt this is, and should be, your most important financial focus. What exactly does that mean, and how can you do it? The answer is easy – but dedication is the challenge.

Step One: Stop Using the Cards.

Plain and simple.  Credit cards should be for emergencies ONLY.  If you want to be successful in paying off your debt, you need to stop adding to it each month.  If you have recurring charges on your credit cards, move those to your debit card.

Step Two:  Understand ALL of your debt.

It’s not just credit cards.  Many people make the mistake of listing out only their credit card debt, and ignoring things like car loans and student loans.   You need to pull out all of your debt and list the following information for each: total amount owed, interest rate, minimum payment, usual payment (assuming you pay more than the minimum on at least some of the total debt.)

Step Three: Make a Plan
List your debt from highest interest rate to lowest.  Add up the payments you are making on everything each month. Now look at your total payments: pay the minimum on everything but the debt with the highest interest rate – apply the balance of payment to the highest interest debt.

For example:
Credit Card:
Owe $17,643, Interest is 11.95%, Minimum Payment $380, Typical Payment $750

Car Loan:
Owe $12,545, Interest is 7.89%, Minimum Payment is $303.36, Typical Payment is $400

Student Loan:
Owe $63,135, Interest is 2.99%, Payment is $329.83, Typical Payment $350

This borrower is paying $1,500 every month for debt repayments.  To apply the principle explained above the new payments would be:

Credit Card
Payment: $866.81, Car Payment: $303.36, Student Loan Payment: $329.83.
At this rate, the credit card will be paid off five months faster!

Once the card is paid off, the new repayment scheme turns into:

Car Payment:$1,170.17 ($866.81+$303.36),
Student Loan Payment: $329.83.

This is where the magic happens: now the car will be paid off in only 6 months, instead of the 2 years that would have been left on the loan. After the car is paid off the student loan payment turns into $1500.  This pays the student loan off in another 3 years.  It basically turns a 20-year student loan into a 6 year loan.

And the example above could save well over $10,000 in interest payments alone.

Step Four: Stick to It!

The hardest part of the process is to stick with the plan.  The example here is a 6-year debt payoff plan.  It’s easy to fall off course in 6 years, but far better to be done with the debt in 6 years than the original 20 years it would have taken.

Of course, you can always make MORE payments and extinguish the debt even quicker.  If you make extra payments, always put it towards the highest interest rate debt first.

Step Five:  Understand the Payoff.

What you need to remember is the amount you are paying for monthly debt repayments.  If you are currently paying $1,500 in debt payments each month, when everything is paid off you will have $1,500 every month to spend on yourself!  Imagine $1,500 every month to go towards your goals.  If you want to buy a house and need $20,000 for a down payment, you can have that saved up in about a year!

Keeping your eye on the prize is the way to stay on track when paying off debt.  And the prize is what you can pay yourself when the debt is eliminated.

Further Reading

• 4 Ways to Start Lowering Your Debt (2)
• Goodbye Credit Cards – 5 Easy Steps to Prepare Yourself (5)
• Knee Deep in Debt? Kick Up Your Heels (0)
• The Hidden Costs of Debt Consolidation (3)
• The ABC’s of Budgeting and Finance : P – T (0)

Tags: Credit, Credit card, Debt, Debt consolidation, Finance, Interest rate, Loan, Payment

This entry was posted on Thursday, August 28th, 2008 at 12:42 pm and is filed under Debt. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.