At this point, you have organized your finances, figured out each and every debt you owe, and you want to start eliminating your debt. You have decided to eliminate debts one at a time until they are all paid off, rather than spreading "extra" money around to a variety of debts. So, which debt should be eliminated first? As with all other issues, you have a number of choices: I have outlined 3 of them below.
The first one, which is the most complicated, takes into account a person's need to pay down debt quickly for a psychological boost and to have money to use to pay down other debt. This comes from the Oprah Debt Diet, and is called the DOLP method: Dead on Last Payment. You'll need your calculator for this one, but it takes a somewhat common-sense approach to your debt.
For each debt, you divide the minimum monthly payment into the total amount due. The result is your DOLP. After you have gotten a DOLP for each debt, you place them in order from lowest DOLP to highest DOLP. The lowest DOLP is the first debt to pay off with your "extra" money, and you continue to pay them off, in DOLP order from lowest to highest, until all of your debt is paid off.
If my family were to follow this advice, we would change around some of the debt we were planning to pay first to last, and, for this moment at least, it would result in us paying off our mortgage as the second to last debt. However, I think the intent of DOLP was not to include mortgages and home equity loans, but rather credit card debt and other types of revolving debt. The good point about the DOLP plan is that it will most likely result in getting rid of some of your debt quickly -- leaving you fewer debts to worry about and giving you more money to pay down the next debt.
The second method I found was on Quicken.com. On that site is a debt calculator in which you can put in all of your debt. It will ask you for the amount you owe, the interest amount and the monthly payments. If it is a tax-related debt, such as a mortgage or home equity loan, it will also ask for your tax bracket. Then, it will calculate how long you will be paying your loans and how much total interest you will pay if you continue to pay the minimum.
If you continue with the Quicken program, it will allow you to put in an amount that you can pay right now to reduce your debt and tell you what to do with that amount. The next step is to put in the amount you can devote monthly to eliminating your debt. It then recalculates how this increased debt payment will impact on your overall debt and creates a plan for the first year about which debt to pay off first and the order of the increased payments. (Click here for the Quicken Debt Calculator).
The Quicken method takes your debt in order from highest interest payment to lowest interest payment while accounting for the tax consequences In that respect, it is a bit simplistic. On the other hand, it provides a concrete plan with excellent suggestions on the order of your debt to pay off if your main goal is to reduce the overall amount of interest that you want to pay.
The third method is my own, somewhat more intuitive, method of paying off my debts. I looked at all of my debts, and decided that what I need, up front, is to get rid of the smaller debts that just eat up money. They seem like nothing because the minimum payments are $20.00 - $25.00. However, when I calculate it out, by paying the minimum, I am more than tripling the length of time I am paying those debts and paying more than 1/2 of that minimum toward interest. That feels like a huge waste, so those two debts are the first two to go. At first, I thought I would throw my "extra" $175.00 at both of them. I recalculated and decided to get rid of the smaller one first and the larger one next.
I am then going after the smallest credit card I have outstanding. Then, I have to decide because I have similar amounts outstanding on other credit cards. In that case, I will pay down the higher interest rate cards first, followed by the lower cards second.
In addition, I have decided on two other things that are important both to our credit scores and to the overall financial health of our family. The first is that we want to get rid of debt in a hierarchy even though that might cost a few dollars more in interest payments. The credit card bills are, in my estimation, the worst bills we have: they just eat up money, and, when you pay them off, many times you ring them up again. That is why I just want out of them altogether.
HIgher up in the hierarchy is "fixed" debt. The good thing about fixed debt is that there is a point at which it will come to an end. Thus, even before all my credit card debt is paid off, I have a couple of loans that will end and free up more money to put into paying off debt.
Then is my "mixed" debt: a home equity line that has an interest only payment and a "balloon payment" at the end. What a mistake that is. That is a debt that really allows a person to over-extend him or herself. If I had to pay principal and mortgage amortized over the life of that loan, I may not have been qualified for it. On the other hand, the interest payments are tax deductible (not all home equity loans are; it depends on what you use it for). That's my next debt to go after -- before car loans or student (parent) loans.
Finally, the best loan we have is our mortgage. Although the payments are high, if we had not got into other debt, they are reasonable in terms of our income. The tax write off makes the loan much cheaper and the interest rate is good and, more importantly, fixed. That is by far the last loan that I am going to pay off.
Other than creating this hierarchy, I have also decided to reevaluate my system on a 6-month cycle. Right now, all my debt is written down, placed into my Quicken software, and, I have paid my first "extra" payment on my smallest outstanding debt. In six months, the two smallest debts should be paid off and I should be coming close to paying off a third debt. I want to recalculate using one, or all three, of the methods outlined here. This will allow me to not only see progress, but see if there is more we can be doing to become debt-free.
For those of you out there who are just starting to take control over your money, do not despair. When I first looked at it all, I felt absolutely overwhelmed. Today, I feel great: I have a plan I have been implementing and I am taking action. My debt has not really decreased; however, I am in control over it because I understand it more. That is really what it takes to take control over your money: to pull it all together and make decisions about it.