Join Jane Barratt for an in-depth discussion in this video Debt repayment fast track, part of Personal Finance Tips.
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- Do you carry credit card debt? Though most of us use credit cards on a regular basis only about half of us carry a balance from month to month. In industry speak those who carry a balance are called revolvers, because the creditor makes money by charging interest on that revolving balance. Those who pay off their monthly balance are called transactors, and because creditors don't get interest on those accounts sometimes they're also called deadbeats. In this case being a deadbeat is a good thing. We want to help you become a deadbeat with three methods to repay debt based on your most pressing motivation.
But before we can get out of debt we have to get our cash flow under control. It sounds obvious, yet one of the most common mistakes that people make is they throw a bunch of money at their credit cards and leave themselves short when expenses are due. Then out comes the plastic again. You cannot get out of debt while you're still incurring debt. If getting your cash flow under control is easier said than done I recommend going through my course Financial Wellness: Managing Personal Cashflow. There you'll learn strategies to bring income and expenses into balance, and how to integrate debt repayment with other financial goals like building your contingency fund.
Next, take a moment to gather your latest credit card statements, download our Financial Wellness Credit Accounts Organizer, which I've provided in the exercise files, and fill out the card name, Balance, Credit Limit, and Interest Rate for each account. This allows you to see all of the relevant information in a straightforward and easy to understand format. See the box at the bottom that says Monthly Debt Payment? That's the amount that it costs you to maintain your debt each month. You're ready to get out of debt when you can afford to reliably pay more than that each month.
Now we get to select a repayment method. Your debt repayment method is basically a way of organizing your debts based on your top priority. If you want to get out of debt as quickly as possible Efficiency Expert is the method for you. We pay off debt quickly when we put our target on the highest interest rate. Use the Credit Accounts Organizer to list cards in descending order from highest rate at the top to lowest rate at the bottom. While paying just the minimums all your other cards put the remaining amount of your repayment money toward the highest interest card.
Repeat each month until this account is down to zero and then move the next card up into the number one spot. Another option is the Snowball Method, which works great when your priority is to quickly reduce the number of accounts you manage. To use the Snowball Method arrange your accounts from smallest balance at the top to largest balance at the bottom. Just like we did with Efficiency Expert the idea is to pay the minimums on all of your accounts with any remaining money going toward the account in the first position. Even though this method may technically cost you more in interest than the first method, moving from seven account balances down to three can reduce the stress caused by having to track seven different due dates.
Also, once you're done to fewer accounts you can always switch to the more efficient way of targeting high interest. Oh, and by the way, you probably don't wanna close accounts once they're at zero, as that can ding your credit score. Just keep the cards out of your wallet, so you won't be tempted to use them again. The third option is No More Tears. With this we simply pick the debt that annoys us the most. Maybe it's money you borrowed from your Uncle Jim and every time you see him he needles you about paying him back. Or maybe you resent the way a certain card wouldn't remove that one late charge.
The reason is up to you. The point is it goes into the top spot and it stays there until it's gone. Remember, your rate of debt repayment shouldn't be so aggressive that you have to eliminate all fun and comfort. Find a balance between paying down your debts and having enough money to do the things that are important to you. And when you do achieve deadbeat status keep the good habit going by simply turning your same debt repayment practice into a regular savings practice.