How to Reduce Your Debt
Debt is not in and of itself a bad thing; it is actually the grease that keeps the U.S. economy moving. However, debt has taken on a negative connotation during this economic recession with out-of-control consumer spending, people living beyond their means, and individuals borrowing more money than they can afford to pay back. These issues have all contributed to the current financial crisis. If you find that you have accumulated too much debt, there are various ways to tackle it. Here are a five suggestions to get you started.
Understand Your Expenses
You didn't get into debt overnight. First, there was the student loan payment. Then the new car. Then the house. Then the credit card debt, and pretty soon it all became overwhelming. The first step in reducing debt is to get a handle on it all.
Produce a list of all your expenditures: mortgage, cell phone bill, medical expenses/prescriptions, car loans, magazine subscriptions, etc. Then categorize them into fixed expenditures (i.e., mortgage and car loans); items that are necessary but not fixed (home phone bill, fuel, etc.); and items that are highly variable (clothes, dining out, etc.).
Create a Budget
After coming to a solid understanding of your expenditures, prepare your monthly budget. Include all of the expenditures you just calculated -- everything from that $2 cup of coffee that starts your day to the dry cleaning bill to your monthly car payment. Then make a list of all your debt obligations and the interest you're charged for each.
Create a line item in your monthly budget for debt payoff. This number needs to be above the minimum payments on your credit card statements. Once you determine the maximum amount you can pay off each month, pay down the debt with the highest interest rate first (which usually means your credit card balances). Once the debt with the highest rate is paid off, put your money toward paying the debt with the next-highest rate, and so on.
If you have debt besides your home, don't be overly ambitious in paying off your mortgage. Mortgages tend to have lower interest rates than other debt, and you can deduct the interest you pay on the first $1 million of a primary-home mortgage loan.
Lower Your Expenses
After you've created your budget, think about how you can dedicate more money to paying off your debt. Cut down on the extra items in your variable spending category, and put the extra money toward your debt payments.
For many people, reining in discretionary spending for a few months goes a long way toward tackling debt. But if that's not enough, move toward reducing your fixed expenses: think about lowering your household bills, refinancing your mortgage to get a lower interest rate, or asking the credit card company to lower your interest rate.
Increase Your Income
Consider whether there's any way to boost your take-home pay. Even though the job market is still struggling, it can't hurt to ask for that well-deserved raise or to post for an open position within (or outside of) your company. If you get a big tax refund every year, that means you're having too much withheld from your paycheck. If that's the case, you can reduce your withholding by changing your W-4 at work.
What Not to Do
It may be convenient to borrow against your home equity or your 401(k) to pay off debt, but that can be dangerous. It puts your home at risk and means that you may fall short of your retirement goals. Even if you can't manage your monthly debt payments, lenders are often willing to work with you to create a repayment plan that you can manage (without putting your home or your retirement at risk).