One of the biggest problems facing Americans today, and, my family in particular, is the mounting debt that is crushing us financially. If we do not take control over our debt, it will decrease our lifestyle, and make it extremely difficult to live as we wish. Ideally, we would be entirely debt free from our "best debt," for example, the mortgage on our home, to our worst debt, store credit cards or other unsecured loans. After extensive research, my family is working on a system of becoming debt free by paying down our debt more quickly than we would if we paid it either minimally each month, paid it and rung it back up, or paid it randomly. Ultimately, we want to get rid of our debts altogether and never borrow again; however, that means that we need to find the money to pay for everything in cash (or by use of a credit card that gets paid off each month). This means cars, tuition, everything big and small. This is an ultimate goal, but it is not a realistic goal for the very near future. This is a hard goal to accomplish mainly because we have some serious debt that must be paid off. So, how are we doing that while trying to save for both the long and short term? This has been the question of the summer. But, as my father-in-law has always said, paying off debt is a guaranteed return on your money (of the amount of interest). So, that's the most important thing.
There are many experts who can help you to eliminate your debt. I consider this the most important aspect of any program of wealth building. Some programs that I have found particularly helpful in jump-starting my debt-reduction efforts and helping me to figure out how to take control over my debts include the John Cummuta Debt to Wealth series and many of the products created in the Rich Dad series.
The first step was to organize our finances in general and our debts in particular. To engage in any kind of program of debt reduction, you need to know what you owe, how much you pay monthly on that debt, and what your interest is. Obviously, you want to get rid of higher interest debts first, but, remember, you are trying to get rid of some debt to free up the monthly payment on that debt in order to increase the monthly payment on another debt. Thus, you may want to work on your smaller debts first: the money you no longer owe to pay that debt can be added to the minimum on another debt payment.
It is a fairly simple concept: my family owes money for a mortgage, a home equity line of credit (which can be paid interest only -- not a smart idea at all), our time share, 2 cars, 2 student loans, 4 credit cards, one loan, and 2 store credit cards. Our balances are very small on the 2 store credits and so, we are attempting to pay them off first. They happen to be the highest interest, but we have another reason for paying them off first: once we have paid one of them off, we have freed that monthly minimum to pay down another debt. So, once we pay off the first store card, we'll add what we were paying to that card to our other store card debt, more than doubling the minimum payment. We will then add both of those payments to our already existing payments on the credit cards (smallest balance first -- largest balance last in order to free up more "extra" payment money sooner), then to the loan, the student loans (Parent Plus Loans), home equity line and finally the mortgage (or, we might switch the Parent Plus Loans with the home equity loan -- the difference has to do with taxes).
To break down the plan, let me use the following example: let's say I had 2 store cards and 4 credit cards. Each store card has $500.00 on it with a $20.00 per month minimum payment. Each credit card has $5,000.00 on them and allow their minimums are $150.00 per month. Each of my minimums, by the way, will go down, every time I make a payment and add no purchases to the card. In this example, though, my total monthly minimums for store and credit cards equals $640.00 per month before I start my debt repayment plan. Instead of paying $20.00 per month on card 1, though, I am going to begin paying $100.00 per month until it is paid off. (How to find that extra money is the subject of a number of other articles on the site.) This increases my total monthly payments to $720.00 -- which it can stay until my debts are fully paid off. I keep the rest of my payments even at the level they are at from this month; thus, I need to find an extra $80.00 per month to get started with this program. (I could start with less or more, but I must start with something). As soon as I finish paying off card 1, I take the $100.00 I am paying on that card and add that to the $20.00 I pay on card #2 so that my monthly has not changed, I am just shifting it. Now of the $720.00 I am paying per month, $120.00 is being applied to card 2 until it is paid off. Then, I add that $120.00 to the $150.00 I am paying on the first credit card that I want to pay off (highest interest or lowest balance). This is when a huge change starts to happen; now the same $720.00 is at work, but $270.00 of it is going to one of my cards. Eventually, I'm paying the entire $720.00 per month to that last card until it is paid off.
Obviously, this plan is an excellent idea, but entirely unworkable if you are not disciplined. During the time that you are attempting to pay the debts off, you have to stop spending more on the credit cards and basically get rid of most of them when they are paid off (because of credit scores, however, you may not want to close them: we have put all our credit cards in a cabinet high out of reach). Want some motivation. Think about this true example of just one of my store cards: One store card we owe has a 675.00 balance on it. The finance charge was $13.13 this month. If I paid them the minimum, $20.00 per month, I would be paying essentially $7.00 per month in principal and $13.00 per month in interest. Although that amount will change slightly every month, just a rough calculation shows me that at this rate, I'll take 96 months to pay off the $675.00 and will have paid over $1200.00 in interest. So, approximately two times what I will have paid over the lifetime of this debt will be added to the cost of my purchases by paying it down on their minimum payment schedule. On a payment schedule of 100.00 per month, I'll be paying them at least $87.00 on the principal every month, which, without a complex mathematical formula, means I will pay this debt off within 7 months and will have paid less than $100.00 in interest. Imagine applying similar reasoning to all your debt and you can see the importance of paying off your debt as quickly and efficiently as possible.
This is what my family is doing. We wrote down our minimums and picked our first card and increased the minimum from $20.00 to $100.00 per month. Although the minimums on our debt will decrease as we continue to pay, we are going to pay all of our debts, every month, at the level we pay them this month, raising the minimums one card at a time. We are also sticking extra money on our interest only home equity debt because the money we borrowed will just cost us too much if we pay only the interest and none of the principal. But, basically, we are trying to increase one payment by as much as we can until that debt is paid off giving us more money to pay off the next debt.
Are we going to make a massive change if this is the only amount we can increase our payments by? Yes -- however; if we can increase the card we are paying off by even more, we will do so; right now, that is all I am sure we can do and still take care of our other obligations. The major problem is having the discipline it takes not to increase any of the debts we get rid of, and, to try not to add any other debts that increase monthly payments. (For example, we cannot spend more than a certain amount per month on a new car, because that is what we spend now.)
Do we have that sort of discipline? Not entirely. But, we need to find it. That is why we are looking into a mentoring program that will help us to maintain this debt elimination system and keep us focused and accountable. We are also constantly looking for ways to decrease spending and gain more revenue, both of which will allow us to keep paying down our credit cards without feeling deprived. If we manage to stick with our system, with or without the mentoring, we will have decreased our debt significantly in a lot less time than if we do not change our habits. Doing this will save us thousands of dollars in what is essentially wasted money: the money we pay in interest provides us absolutely no value -- whatever it bought us in the past is consumed already and it makes it more difficult to get the things that are important to us now. To pay off interest requires a lot more work than to pay for the important items at the time they are bought.
The hardest part is not added any debt. So, when a card is paid off, you need to put it away: -- in the cabinet, a safety deposit box, a block of ice. We actually shredded one card and closed the account (but that was in anger), you may want to keep your accounts "open" and not use them because it does increase your credit scores to have open lines of credit. Also, you might want to have emergency credit cards if you do not have emergency savings. You may also want one card that you pay back monthly just to get rewards (but, I think that should be a minor consideration if you are trying to eliminate debt). If you do decide to keep credit cards with you, use them like cash: pay them off at the end of the month. And, once you get out of debt, stay out!!! I would love the feeling of freedom that having no debt allows people. That is why we are working so hard to eliminate our debt.