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Home » Random

Control Your Debt (part #2)

Pile of old cards
Creative Commons License photo credit: kalleboo

This is the second part of a two part post on controlling debt, which is the first step to finanicial freedom.

In the first post we looked at the  difference between Good Debt and Bad Debt, in part two we look at strategies for dealing with bad debt.  If you missed the first part of the post you can catch up here : Good Debt and Bad Debt

In this post we look at the strategies for dealing with ‘bad debt’

Dealing with ‘Bad Debt’

If you want to know the difference between good debt and bad,  for the purposes of this post we’re defining good debt as debt used to purchase things that go up in value such as a house or fund education which enables you to get a better job.  Whereas bad debt is used to purchase things that typically go down in value such as a TV, a car a stereo or an iPod.

However you can’t take control of what you spend unless you know how much you owe.  You can download a free Debt Template to help you with this task here.  Get all your credit card statements (open the envelopes) and be honest with yourself. Now is not the time to ignore the pile of unopened envelopes on the kitchen worktop.

Go on do it now. The quicker you start the quicker you can take control.

Finished it? Well done. You’ve just taken control.

To  take control of your finances we have to ruthlessly eliminate debt.

This post assumes that you can afford to make your monthly payments, and you aren’t in arrears. If you are experiencing problems paying your debt or are in arrears, you need to take professional advice.  In the UK you can try National Debtline or in the US The Federal Trade Commission (If US readers have better sources of Free advice, please let us know in the comments section below).

The first step is to stop adding to the debt. Put your credit cards away (take them out of your wallet or purse) or cut them up, just don’t go buying anything on them you can’t afford.

If you only pay just the minimum payment  of your credit card each month it will not only take you longer to pay it off but cost a fortune in interest payments.  For example if you spend £250/$250 on a new iPod and pay the minimum amount each month (£5/$5) , it will take 9 years to pay off and cost you £290/$290 in interest (at 20%).  I don’t know about you, but I don’t fancy having a 9 year old iPod.

Now as you will see from the debt spreadsheet, some debt costs more than others. Now there’s two schools of thought here about which debt to pay off first:  1) pay the most expensive debt first 2) pay the smallest debt first (that way it gives you a psychological boost when you’ve paid it off).

Financially, it obviously makes the most sense to pay the more expensive debt first until it’s paid off then moving to the next most expensive. But, it doesn’t matter which one of these strategies you follow, just as long do something and the sooner you do it, the quicker you will pay it off. Obvious yes, but you can make dramatic differences just by paying small amounts off:

Ways to knock months off your credit card bill

If you pay just 10% more than the minimum payment each month then you will reduce the time it takes to pay for the iPod in the above example,   from 108 months to 85.  That’s right, nearly 2 years.
Fix the amount you pay on your credit card. So if the minimum payment is £50 / $50 per month, contact your bank and set up a regular payment for £50/$50.  Because If you pay just the minimum payment, then you will be reducing the amount of money you’re paying back each month as the balance reduces. Locking in your payment will compound the effect of your payments and reduce your debt much more quickly.
Although charged monthly, your credit card applies interest daily. So instead of paying the amount you would normally pay at the end of the month, divide it into to 4 and make the payment each week.

As you pay one credit card, roll the payment from that credit card and increase the payments on another card by the same amount.

Similarly, if you get a pay rise or extra income you weren’t expecting then use that extra amount towards your debt but avoid any temptation to go and spend it on something you fancy.

So, how have you dealt with debt?