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Credit cards are often used for large purchases and often by spending money that you have not yet earned.  The overuse of credit often leads to high debt levels, which can prevent people from ever getting ahead and reaching their financial goals. While there are many common-sense ways to deal with debt reduction, we want to walk you through a few key ideas that we believe are essential in any debt management strategy.

If you have little or no debt, congratulations, let’s keep it that way! If, however, you have a high amount of debt, as many Americans do, we are going to examine the key decisions that begin to mitigate debt accumulation and eventually lead to its elimination

If your debt consists of only a home mortgage with a low-interest rate and a low balance car loan, you are in pretty good shape from a debt standpoint.  However, if you have 2 or more high balances on car loans and high balances on multiple credit cards, your debt is not only hurting you financially but limiting your progress towards your goals.

Regardless of your particular debt situation, begin with the following exercise so that you can clearly understand the effect that debt is having on your finances:

  1. List all the credit accounts that you have, wherein you owe money and pay interest on an ongoing basis (first and second mortgages, car loans, bank/ credit card accounts, student loans, etc…
  2. Add the total interest to be paid for each account to arrive at the grand total amount of interest that you will pay on all of your accounts. If you have never looked closely at this information before, the amounts can be alarming. For example, on a thirty-year 6 % fixed mortgage loan of $400,000, $463,353 will be paid in interest over the life of the loan. On a 12 % credit card account with a balance of $15,000, where a near minimum payment of $155 is made each month, $37,080 will be paid in interest over twenty-eight years.
  3. Looking at your list of primary financial goals and priorities (like retirement, college savings, etc.), consider which goals you may have to defer and/or sacrifice because of the total interest you will pay on the debt you owe. Conversely, consider which of your goals you may be able to achieve much sooner if you are able to eliminate having to pay a significant portion of that interest.

The previous exercise can be very enlightening since some people never look closely at how much of their hard-earned money goes toward paying interest. If you reduced the amount of interest that you must pay, you would have more money to allocate toward your goals and your overall financial security. With a good debt elimination plan, it is possible to save tens and even hundreds of thousands of dollars in interest over a person’s lifetime.

If your debt is significant and/or overwhelming to the point where you question whether you can develop a plan to reduce it within a reasonable timeframe on your own, you may want to consider obtaining help to develop a debt elimination plan. There are many free and fee-based companies and organizations that can help you develop a plan to reduce and ultimately eliminate your debt. Before choosing a person or an organization, do your homework to ensure that they are reputable and that the fees they charge, if any, are reasonable. If your debt is small-to-medium, and you are comfortable developing your own plan, you may want to consider some or all of the following as part of your plan:

  1. Pay more than the minimum payment amount, especially on high-interest accounts. This will reduce the amount of interest that you will pay as well as reduce the time that it will take to pay off your credit accounts. Doing this particularly on high-interest accounts is critical. Many revolving credit accounts like bank cards and store credit cards have minimum payments that are barely addressing the principal each month. In order to bring down the total amount you own in a meaningful way, you will need to pay more than the minimums.
  2. Consider consolidating your debt if you cannot make more than the minimum payment amount on most of your accounts. If you own a house, a good way to do this may be to obtain a second mortgage, or equity line of credit, against your house. The interest rates are typically lower than other types of loans, and the interest paid is often tax deductible.
  3. Pay off higher-interest non-deductible accounts first. A common pay off order might be: Store credit accounts, bank credit cards, car loans, student loans and, lastly, mortgage loans.
  4. Carefully evaluate your options before you refinance your mortgage. Even though you may be able to lower your monthly payment, the total interest you pay on the new loan may be more than what remains to be paid on your existing loan because of the way mortgage loans are amortized (most of the payment initially goes toward interest for more than half of the life of the loan). Additionally, your pay off date typically gets pushed out further in time every time you refinance.
  5. Consider transferring your credit card account(s) that charge interest to an interest-free credit card account. Many credit card providers offer six to twelve-month interest-free transfers. Read the fine print carefully, because there may be transfer fees, and you may have to pay off the entire transfer amount in full at the end of the promotional period, otherwise, you may have to pay interest penalties. But even considering some of these costs, for people making aggressive payments against their credit cards, having a 0% interest period can help them be more successful over a short period of time.
  6. Resist getting further into debt whenever possible. Try to save up the money to make most of your purchases with cash or a debit card. This may mean not putting every excess dollar you have against your credit cards. And while this may not seem intuitive at first, it can be very important. Because debt reduction can be a long process, you are likely to incur unexpected large expenses during that time: new tires on the car, roof repairs, etc. Making sure you have emergency funds on hand to address those concerns while you are paying down debt can help you avoid discouraging setbacks.
  7. Carefully evaluate interest-free purchase offers. This again is typically borrowing from future earnings, and, even though it is interest-free, it is still debt that you will owe. There can also be significant interest penalties if the amount borrowed is not paid in full by the end of the promotional period.

Depending on how much debt you have, it may take quite a few years to pay off all of your debt. Do not get discouraged if your progress is slow initially. Keep focused on your goals and your long-term financial health. As you get raises in your pay and begin to pay off some of your debt, you will be able to allocate more toward paying off the remaining debt and your progress will accelerate.

It is a liberating feeling to be “debt free.” Once people achieve this (all too often) unique position, progress toward their other financial goals begins to accelerate as well. Developing a plan to reduce and ultimately eliminate your debt so that you will no longer have to pay interest to financial and retail institutions is critical to overall financial health.

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