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Managing Your Debt, Part 4
You’re in the home stretch of these 4 parts on Managing Your Debt. In part 3, you learned about the toll that debt can take on your finances, and your personal life.
In this Part 4, we’ll teach you how to finally get control of your debt and your life. You’ll also learn about some of the traps you can get into as you work your way out of debt. These traps sideline many people on a debt-reduction path, causing even more damage to their credit and adding additional strife to their already complicated financial lives.
Debt Resettlement
If you’re deeply in debt, then chances are pretty good that you’ll start to get offers from companies who want to help you settle your debts. Some of them may come out and tell you that’s what they’re going to do to help you get your debt under control.
However, some will actually get your attention by promising you a consolidation loan or line of credit, which you can use toward your debt. Once they have you on the phone, the true story begins to emerge. Your loan isn’t really a loan. It’s a debt resettlement deal.
A company of this sort instructs their clients to stop paying their creditors. The company also offers to negotiate deals with the clients’ creditors. It’s best to avoid these types of situations if you can. In the long run, you may find your credit takes a nosedive. You also have no guarantee, despite the company’s promises, that your creditors will accept the deal the debt resettlement company offers them.
Prepayment Penalty
Do again be aware that some lenders may want to charge you a prepayment penalty fee for paying the debt off early. Before you embark on your debt repayment plan, find out if any of your creditors charge you a prepayment penalty for paying a bill off early.
If they do, then you’ll have to weigh out your options and decide whether it’s worth it to you to pay the debt off early, even with the prepayment penalty. However, if there is no charge for this, then do it. It’ll reduce the amount of interest you pay and get you out from under a bill a lot faster.
Your Debt Reduction Strategies
If you follow the advice in the next two sections - the High-Cost Debt First and the Snowball methods - then eventually, you will be able to correct your debt problems, given enough time and patience. This empowers you to take control of your finances and learn how to manage your money.
Finally, it should be noted that whatever debt-reduction strategy you choose, it’s going to work best if you stop creating more debt as you pay off the debts you currently have.
1. High-Cost Debt First Strategy
If you decide on this debt-reduction strategy, then you’ve committed to paying all of your debts off, starting with the debt that has the highest interest rate first.
Basically, what you’ll do is pay the minimum payments required on all of your debts except the one with the largest interest rate. With that debt, you’ll pay the minimum PLUS any extra money that you have until you get that large debt paid off. Your extra money could come from a tax return, a second job, a side business, or by selling some of your stuff.
Once your debt with the largest interest rate is paid off, you then move on to the debt with the second-highest interest rate. Follow the same procedure. Pay the minimum on each debt, except this one. Repeat this until all of your debts are paid off.
Here’s how this might look with a hypothetical debt breakdown. The following bulleted list shows what each debt is and how much money still needs to be paid on it before the debt is paid off.
· Credit card 1 = $6,300 at 12% interest
· Credit card 2 = $1,500 at 19% interest
· Personal loan = $5,210 at 6.8% interest
· Car loan = $500 at 7.5% interest
With this repayment plan, you’d pay off credit card 2 first, then credit card 1. After that, you’d tackle your car loan and then, finally, the personal loan.
Before you get started on this method, make a list of your creditors, just like the one you see above. Rank each debt according to how you’ll pay it off, starting with the credit that charges the most interest.
There are a couple of important things to note. When you’re paying extra on your debt, be sure to instruct the creditor to put your extra money toward the debt’s principal. As we already discussed in a previous section, you pay interest on the amount of the principal. If your principal is less, then your debt is less.
Also, make sure that each lender gets at least the minimum that it requires and make sure this payment is on time.
· Advantages to this method: You save money because you’re taking care of the highest interest rates first.
· Disadvantages: You may feel like you’re paying on your debt forever because you’re not tackling the smallest debt first. Rather, you’re tackling the debt with the largest interest rate, which may be bigger and therefore, take longer to pay off.
2. The Snowball Method
Much of the mechanics of this strategy work exactly the same way as the strategy above, meaning that you you’ll pay at least the minimum amount on each debt each month. You’ll also pay any extra money you have toward the debt you’re tackling first. And again, you’ll follow this course until all of your debts get paid off.
What’s different about this method is that instead of paying off the debt with the highest interest rate first, you’ll tackle the smallest debt first.
Let’s look at the hypothetical list of debts again:
· Credit card 1 = $6,300 at 12% interest
· Credit card 2 = $1,500 at 19% interest
· Personal loan = $5,210 at 6.8% interest
· Car loan = $500 at 7.5% interest
This time around, instead of starting with credit card 2 as your first priority, your car loan is going to be the bill you pay off first. This is because you only owe $500 more on your car loan, and then the car is paid off: This is the smallest debt amount you have.
You’ll then move onto credit card 2, then your personal loan, and then finally, credit card 1 in that order. This method gives you a psychological boost because you can see many of your debts disappearing very quickly. That’s why you begin this process with the smallest debt first.
Finally, be sure to ask each creditor about any early payoff penalties, and as with the example above, do be sure to instruct your creditors to put any extra money you pay toward the principal of your debt.
· Advantages to this method: You get a psychological boost from paying off some of your small debts very quickly.
· Disadvantages: You may pay more in interest than you would with other debt management payoff plans.
Final Thoughts on Section 4
Debt reduction strategies, like High-Cost Debt First and the Snowball methods help people get out of debt by giving them specific strategies for debt repayment. Using these strategies allows you to take charge of your own debt-payoff plan.
However, you may find that before you can implement your plan, you may get sidetracked by companies that promise you debt renegotiation services under the guise of consolidation loans. Your best bet is to stay away from these services and learn to take care of your debt without them.
