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4 Steps to Getting out of Debt

A recent report from The Pew Charitable Trust stated that 80% of Americans are in debt. The primary areas of consumer debt are mortgages, student loans and credit cards. These types of debt can generally be thought of as either good debt or bad debt. Borrowing to secure a home or acquire a college education is considered good debt because these assets (yes, an education is an asset) hold significant long-term value. Although credit cards can be extremely useful in cases of emergency and are exceptionally convenient in everyday commerce, they promote a buy now pay later culture. Thus, it is easy to build up sizable credit card balances which may ultimately cause difficulty later. Furthermore, this may also prevent you from addressing other financial obligations which can impact your financial well-being.

Here are a few steps that can put you on the right path to getting out of debt.

Step 1 – List all your all debts from the largest to the smallest. The purpose of doing this is to not only get a visual of your full financial picture, but to organize all your obligations in a comprehensive way so you can effectively implement your debt reduction plan. A debt reduction plan is a personal strategic approach to reducing your overall debt. Once you’ve listed all your obligations, you should note all your regular monthly payments; particularly your credit bureau reporting accounts. You want to make certain that under no circumstances are monthly credit reporting accounts neglected, as that would undoubtedly prompt further action from creditors and negatively impact your credit rating. Always prioritize payments to credit reporting accounts.

Step 2 – Before you create a schedule to start systematically paying off your debt, there are a few things you’ll need to commit to. 1) You cannot add any new debt during the term of your debt reduction schedule. 2) You must review your overall budget and cut all unnecessary spending (focusing on needs vs wants) 3) Given that your income more than likely will not change and monthly obligations will remain the same, you want to ensure that expenses are not out of control, so as to free up as much funds as possible to be used as a “debt reducer.” (The term “debt reducer” simply refers to the amount of funds that you have set aside either by curbing expenses or by paying off your smaller debts) The debt reducer is then systematically applied to paying off your outstanding debt obligations. The amount of your debt reducer should grow with each pay off.

Step 3 – You are seeking to create a snowball effect. Using funds from your debt reducer you are systematically targeting the smallest to the largest accounts on your list until they are paid off.  (The key to your success here is consistency) Once the first debt is fully paid, target the second smallest and so on until each is systematically paid off. The snowball effect kicks in once you begin to apply the extra funds from each of the (old) paid off debts. This will help accelerate paying off your obligations. For example, if you were paying say $75 a month toward your credit card account of $2,000.00 which is now paid in full, you can now use that extra $75 which can be applied directly to the next monthly payment on your list. Adding an extra $75 to your regular monthly payment will help decrease your debt much faster.

Step 4 – If after reviewing your income, expenses and monthly debt obligations you’ve determined that your situation is too overwhelming to handle — or that it’s simply not within your power to resolve – you should seek the advice of a certified financial planner or consumer credit counsellor. Usually counsellors can help guide you through the process of deciding which debt management option would best suit your needs. Options can range from using a debt consolidation loan, to filing for either of two types of bankruptcies (Chapter 7 or Chapter 11).

That said, be your own CEO. You actually can talk to creditors, negotiate with them regarding rates, payment amounts and even balances. Don’t be afraid to engage your creditors in conversation to your benefit. Taking these key steps will not only help you get out of debt, it will help you improve your financial discipline over time.

Here are a few debt Management resources.
Things to look for from a Credit Counselling Agency
Consumer Credit Counselling

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