Credit Crunch: Put Your Debt on a Diet
Reducing the amount of debt you owe is a lot like losing weight. The keys to success include sacrifice, discipline and a willingness to change your long-term behavior. But whatever you do, don't go on a cash-starvation diet. They don't work. What's more, you may end up feeling so deprived that you'll run to the nearest ice-cream parlor or mall and do some serious damage. The binge-and-purge cycle doesn't work for diets, and it doesn't work for personal finances.
With that in mind, here's an easy four-step plan that can lead to a leaner, meaner and healthier financial life:
Step 1: Step on a Scale
There's no way to avoid it. If you want to lose weight, you've got to step on a scale. Similarly, if you want to reduce your debt load, you've got to assess your finances. That means spending at least one month carefully listing your assets and liabilities.
Here's how it's done: Take your monthly income, minus bonuses and overtime. Next, write down all of your monthly expenses, such as rent, car payments, student-loan payments, utilities, entertainment and the like. Don't forget to average in occasional expenses, such as insurance premiums. Finally, compare your monthly income and expenses.
You should bring home enough money every month to pay your bills and sock away some savings for a rainy day. If your monthly short-term debt payments (that's everything except a mortgage) amount to 20% or more of your monthly take-home pay, it's time to go on a debt diet.
Step 2: Trim the Fat
Okay, you've analyzed your situation, and you know you're bloated. What do you do? Start trimming the fat, but don't do anything really drastic. For example, do you spend a lot of money on magazines, newspapers, books, a seldom-used gym membership or a cable-TV subscription? You can save money by reading publications online, going to the library, shopping at used-book stores, swapping books with friends, riding your bike around the park or doing some volunteer work. You may also want to refinance your car loan or mortgage to reduce monthly payments.
Instead of going out to lunch every day with colleagues, or splurging on that $4 double-cappuccino at your local gourmet coffee shop every morning, why not pack your own lunch or bring your own coffee in a thermos? The money you save may not seem like much, but it can add up to a bundle, perhaps hundreds of dollars, over a year.
Step 3: Get Disciplined
Now it's time to tackle that debt. Pay off high-interest debt, usually credit cards, as soon as possible by paying more than the minimum monthly amount. If your credit is good enough, you can also consolidate all of your credit-card debt on a new credit card with a lower interest rate. But there are some caveats: Make sure the interest rate on the new credit card is lower than the average rate you're paying on all of your credit cards.
Remember, some low "teaser" rates only last a few months, so if you can't pay off your debt in that time, switch again. And most important, stop using your credit cards! What's the point of consolidating your debts if you continue to add to the total amount?
To find low-interest-rate credit cards, compare solicitations you get in the mail or check online. There are many sources where card costs can be compared.
Step 4: Develop Healthy Habits
Sticking to a diet for a month or two can make you look good in the short term. But unless you make permanent changes in your eating and exercise habits, you'll probably gain back all the weight. It's no different with budgeting and debt.
What changes should you make? Never pay for entertainment, food and clothing with credit cards unless you can pay off balances at the end of the month to keep finance charges at a minimum. If you really need to make a big credit-card purchase, try to pay it off within three months. Carry around only as much cash as you think you'll need for the week. After all, an empty wallet is an immediate and visual reminder to stop spending.
Don't panic if you can't do it alone. Lots of free help is available for everything from budgeting to debt reduction from one of many reputable nonprofit counseling agencies in your area. It's like Weight Watchers for the debt-plagued.