Jul 7, 2005

Getting Out Of Debt

Few things are more stressful than being in debt. But committing to getting out of debt can go a long way toward making you feel in control of your finances and even your life. Here's a strategy for getting rid of that debt:

1. Make a list of all of your debts. List the total amount, the minimum monthly payment, the interest rate, and how long it will take you to pay off the debt at the current rate of repayment. (If you're not sure how long repayment will take, try this Bankrate.com calculator.)

2. Add up all of your minimum monthly payments, then determine how much more than that you can afford. For example, if your minimum monthly payments total $500, you may decide that you can afford to pay back $575 every month.

3. Rank your debts in the order in which you are going to pay them off. There are a couple of different ways to do this, and you can also combine methods to suit your needs and personality. One way is to put the debt with the highest interest rate at the top of your list and work your way down. This will save you the most money, since it will minimize the amount of interest that you pay.

Alternatively, you can put the smallest debt at the top of the list and the biggest at the bottom. This method allows you to eliminate debts the fastest, although you may end up paying more in interest.

You may want to put the smallest debt at the top of your list, then rank the rest according to interest rate. That way you can pay off one account and give yourself a sense of accomplishment. Determine what's best for your personality and what you will stick with, and go with that route.

4. Pay the minimum on all of your debts except the one at the top of your list. Take your "extra" money ($75 in my example) and apply it to the principal of that debt. Depending on the type of loan, you may need to make an extra phone call or write a letter to make sure that the extra amount is applied to principal and not simply used to advance the next payment. (An example of this is one of my law school loans. Whenever I pay more than the minimum, the company applies the extra amount toward the next payment and advances the next payment due date - in essence, they treat the excess as the next month's payment. I have to email or call them to instruct them to apply the excess to the principal of the loan and not to advance the due date.)

5. When you've paid off the first debt on your list, give yourself a reward, keeping in mind that any money you spend on that reward is money you're not applying to your next debt. I think a good rule is to limit the amount of your reward to the amount of the monthly payment you had been making on the debt you just paid off.

6. The next month, apply the money from the first debt toward the principal of the next loan on your list.

7. Repeat steps 4 through 6 until all of your debts have been paid off.

8. When all of your debts have been paid, put most of that money into savings and watch your net worth grow!

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