You cannot wish the debt away. What’s done is done and denial won’t get you anywhere other than a heap of sorrow mixed with anxiety. It’s time to face facts and put together a plan to pay off your debts.
Like any plan, it needs to be specific and have a timeline to help you stay on track. Otherwise it’s the “I’ll lose those last 10 pounds sometime”. The time is now, so let’s get busy.
Make a list of your debts, for most of us this is credit cards and loans other than the mortgage. List the dollar amount, interest rate and current minimum payment. Write it, type it, print it and carry it with you at all times. Put a copy in your wallet. Tape a copy to you fridge. Stick a copy on your bathroom mirror. Heck, put one in your car. Get out of denial about your debt and know these numbers. Painful as it may seem, acknowledging the numbers and making them a priority will give you the power to do something about it. It’s also a great reminder to STOP SPENDING and adding to the pain.
1. Snowball your debt payments
Different experts have different opinions on how to snowball payments. Some say pay the highest rate accounts first while others go for the smallest balance first. I’m somewhere in between. Take a long look at the list and put the smallest amount first. If two accounts are close in balance and terms, put the higher interest account first. This is your focus account. Your primary focus is on paying this account off. Paying on this account and getting it closer to $0 will give you quick feedback and a sense of accomplishment and motivation to keep you on the plan.
Once your first focus account is paid off, go to the next account and repeat only this time adding all of the money you were paying on the first account to the next account. If you were paying $200/mo. on the first focus account and $75 on the account next in line you will now pay $275/mo. on your next-in-line focus account. You can easily see how knocking down accounts and building up the payment amount will ‘snowball’ over time and help you get out of debt faster.
2. Pay more than the minimum
We’ve heard this over and over but paying more than the minimum really does make a difference. Add $10 or more to each minimum with the bulk of any extra cash being applied to your focus account. Bite the bullet and pay as much as you possibly can. Apply “found” money out of your daily life (see #6) and save yourself hundreds if not thousands of dollars in interest over time.
3. Renegotiate your rates
Call your creditors, mainly credit card companies or revolving credit accounts, and ask for a lower rate. Explain that you are having difficulties making the current minimum payment. I’ve received as much as a 2% reduction just for calling. If the first person you speak to says no, ask to speak with their supervisor.
Auto loans, student loans and other non-revolving credit accounts are fixed the contract you signed. These loans have little to no wiggle room without refinancing, a process that could have costly fees. For these loans, you may be better off sitting tight.
4. Migrate debt to lowest rates
Take a look at the balances of all of your accounts. On the accounts with the lowest rates, are you at the maximum amount? You may be able to transfer balances from higher-interest rate debt to lower-interest rate cards. You may find it helps your situation to transfer from a 13%-19% card to a 0%-7.9% card, saving in interest and using the savings to apply to your focus account.
Be sure and read the fine print. Is there a fee to transfer the balance? Some cards charge as much as 3% on the balance being transferred. Does the rate automatically skyrocket if you are late on a payment? As the banks are happy to make offers to gain your business, they are equally aware of card-hoppers and may charge you the highest rate retroactively if you move balances within a specified time period.
5. Borrow your own money
Enter into this area with your eyes wide open. There are three areas that you could potentially use or borrow from to pay off higher-interest rate debt. Life Insurance, 401(k) and saving accounts are all potential places to borrow or use your own money to apply towards debt.
If you have a life insurance policy with a cash value, you can inquire about borrowing against it. These rates are typically below commercial loan rates and you can take your time to repay the loan.
If you have a 401(k), you can borrow against your account. Most plans allow you to borrow up to 50% of the balance with interest rates 1-2 percentage points above prime which is cheaper than credit cards. Plus, this is is interest you are paying to yourself rather than the credit card company. Note that you must repay the loan in five years AND if you leave your employer you must pay the the loan back immediately. If you do not pay the balance, it will be treated as a distribution and taxed at an ordinary income tax rates. Additionally, if you are under the age of 59 1/2, you will incur a 10% penalty on the amount for early withdrawal.
If you have a savings account, keep at least $1,000 in the account for emergencies such as car repairs. If you can spring some cash out of savings earning 3% to pay against a 15% debt, it’s a good use of the cash. Do this at your own comfort level.
Whatever you do… do not, not, not touch your IRA or other retirement funds that will hit you with a 10% penalty and a large tax bill later on. Deal with the debt you have now and don’t create a more painful debt with penalties and interest due to the IRS later on.
6. Apply “found” money each month
For some it may be better to try this on a weekly basis but the overall approach should be to “find” money out of your everyday life and apply it to your focus account. Found money can be the cash saved by brown-bagging your lunch and skipping the stop at Starbucks in the morning. It’s digging through the garage, closet and attic for items to sell on Craigslist. It’s pouring out the change jar on your dresser. This is found money and it adds up!
Check with your employer on selling back vacation time. Many employers require you keep a minimum amount of vacation or “paid time off” (PTO) in your account for emergencies. While it is important to take time off and recharge your batteries, if you have PTO you can sellback to your company it could be a fair amount to apply to your focus account.