Money Matters Monday: Best Methods for Becoming Debt Free
Once you have fallen into debt, it can become a mounting avalanche where you are trying to keep up with minimum payments and cannot pay for basic necessities. Working on eliminating debt can be the most liberating experience when you stick to it and you start to see the debt melt away.
First take an honest look at your budget. If you don’t know how to do that take a look at the previous Money Matters Monday article on the topic. The purpose of looking at your budget is to understand how much extra money you have per month to put towards reducing your debt.
Next gather all the bills that you want to pay off. These will typically be personal loans, credit card bills and car loans. The information you need to find is the creditor name, current balance, interest rate and monthly payment or minimum payment.
Then you have to decide what approach you want to take to reducing debt. This is critical to being able to stick to the plan. The main question will be how to apply the extra money you have to your outstanding debt. One method is to apply the extra money to the debt that has the highest interest rate. This will allow you to pay just the minimum payment on accounts that have a lower interest rate so that you are paying less interest in the long run. The downside to this approach is that you may not see results as quickly because larger interest rates are usually attached to larger accounts.
If seeing some results quickly is important to you, then consider paying off smaller accounts first regardless of the interest rate. Again you will feel a sense of accomplishment by paying off a smaller account and being able to add that money to the extra money to continue paying off the debt. The downside here is that you are allowing accounts with a higher interest to accrue large interest balances while you focus on smaller account. Of course if you happen to have a small account with a large interest rate – it is the obvious first choice to be paid off.
One thing to remember is to always take the money that you normally would apply to the minimum payment for an account to the extra fund when the account is paid off. For example, you pay off a credit card that had a $1000 balance and that frees up $60 a month. That $60 should immediately be moved to the extra fund on your budget as you move on to the next account that you want to focus on paying off. As your extra fund grows consider focusing on multiple accounts to pay off perhaps mixing the two methods – focus on one account with a high interest rate and one account with a small balance.
A few key items to remember when paying down debt are to close the accounts when they are paid off. Also be cautious about using zero interest credit cards as a method to reduce debt. Only open one and transfer a balance if you are positive that you are able to pay off the debt before the promotional period has elapsed.
Reducing debt is very simple but it takes great discipline and an appreciation for the freedom that comes with being debt free.