What is the best way to lower my debt?
The risk with taking on new loans is that often
, they end up costing you MORE than the loans they replace because of the term of the loan. (The other risk is that if you pay off a credit card, you're at risk for running it back up again and being worse off than you are now.)
You should only consider taking on a consolidation loan if both of the following conditions apply;
1 - The interest and the monthly payment on the new loan are both significantly lower than the interest and total payments on the loans/debts it replaces; AND
2 - There is no penalty for paying off the consolidation loan early.
If those conditions are both met, then you may be ahead by trading your existing debts for a single large one. However, to make this work, you need to pay more than the minimum on your new loan so that it doesn't end up costing you more, over the life of the loan, than you are currently paying.
However, you should also know the classic way to get out of debt as quickly and inexpensively as possible:
Rank all your existing debts -- your credit cards, student loan, car loan (if any), etc. -- according to their interest rates, with the highest rate as #1. That's your most expensive debt. (As an alternative: if your highest interest rate debt also has the highest balance, consider paying off your debt with the smallest balance first, as that will free up your monthly budget sooner.)
Then, do whatever it takes to modify your current expenses so that you can pay as much extra to debt #1 every month -- the object being to pay down this loan as quickly as possible. With luck it should only be for a short time, so consider even modest temporary hardships, it's for a good cause. On every other debt, pay just the minimum (or as much of it as you can).
Once you've paid off this debt, add that amount onto the monthly payment for debt #2 and pay IT down to zero. Then when it's gone, put that amount toward debt #3, etc.
Get the idea? For example, let's say you have four credit cards with minimum payments of $20, $25, $30 and $35, and that's the order in which you want to pay them down. You've also decided that by giving up one Starbuck's a week you can put another $15 a month into reducing your debt.
So this month you pay $20 + $35 to debt #1, for a total of $55. You keep paying just the minimums on the other three, as soon as you can. In ten months you've paid $550 on your debt #1; for the purposes of this example, let's assume that you get this card down to a zero balance, so it's time for debt #2.
If you recall, debt #2 has a $25 minimum payment. But you have $55 a month that you have been paying to debt #1, which is now at your disposal. So you pay $25 + $55, or $80, to debt #2. Maybe that's a larger amount, let's keep the math easy and say it's $1600, so it takes you 20 months to pay it off. But you do, and now you have that $80 at your disposal (not to mention any raise you hopefully have encountered in the next two and a half years).
Debt #3 has a $30 minimum, so you now have $110 to throw at it. And when it's gone, you can take that $110 plus the $35 a month that debt #4 requires and pay it off at $145 a month.
Get the idea now? From a long-term strategic standpoint, you're always best off to pay your highest-interest debt first because it's the one that costs you the most over time. However, you should be able to see from the example that paying your lowest-balance debt first may be better from a tactical standpoint, because it frees up that debt's monthly payment sooner. This gives you more to throw at your second and subsequent debts.
As another recommendation, if you don't already have a savings plan, consider this: after you've paid off debt #1, use only half of what you were giving it every month to pay down debt #2. With the rest, set up an automatic deposit into a savings account. Just have it put right into savings before you even see it, and then try to forget that it's there.
So in our example, you had been paying $55 a month to debt #1; when you pay off debt #1, consider putting half of that (oh, let's call it $25 a month) into savings. (It's even better if you have access to a 401(k) program at work, because you pay with pre-tax dollars and your employer usually matches you to some extent, but that's another topic altogether.)
The other tip: use personal finance software (I use Quicken) to manage your expenses. Not just for keeping track of what you've already spent -- the real power in a program like this is that you can enter future transactions as well. The program will update your balance as far into the future as you want to make entries, so you can see when you need to adjust a date or whether you can add a little more into a debt this month to pay it down faster. (And Quicken also has a debt reduction planner which will work with your exact figures for balance, interest and minimum payment, and it tells you exactly how much sooner you'll be debt-free if you can follow its recommendations.)
In any event, the main point behind this classic debt-reduction strategy is that you pay down one debt as quickly as possible, putting whatever extra money you have into that one account while just staying current with your other debts. Then you repeat this with the next debt, and the next, until at last they're all down to zero. Don't try to pay more than the minimum on more than one account per month; that only prolongs the agony.
What is the best way to lower my debt?
By: liza
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