By Stuart Ritter on October 13, 2009
To help you eliminate your debt, the most powerful tool you have is the amount you're able to pay every month. Too often, people focus on which debt to pay first, negotiating interest rates, etc.—all of which can help—but skip over the one thing that helps more than anything else. So while it may seem counterintuitive, the place to start with eliminating your debt likely has nothing to do with the debt itself. Instead, your initial step should be to look for ways to increase your income and/or decrease your expenses so the extra money can be put toward the debt.
And don't think of this as a one-time event. You should always be thinking of ways to eliminate an expense and, instead, put the money toward your debt. Also, any 'unexpected' money that comes your way can go toward debt as well. Gifts, tax refunds, etc., can all help.
Once you've identified your financial resources, you can begin to put a plan in place.
First, let's put the debt issue into the larger context of the many other financial goals you're likely pursuing. There are four key areas we think people should address:
- Eliminating debt,
- Building an emergency fund,
- Maintaining adequate insurance, and
- Saving for retirement.
While you may need to emphasize one of these four areas more than the others—depending on your situation—it's generally not a good idea to put all your resources in one area and completely neglect the others. So while you're eliminating your debt, be sure to continue contributing assets to the other three areas. That way, as the debt is paid down you can shift the newly available assets to other areas, instead of having to start something from scratch.
Second, you need to make sure you're not adding new debt. Your spending must be less than what you are earning. You don't want to climb out of a hole with one hand, while digging a new hole with the other.
Third, get a handle on what you owe. While this may feel intimidating—you actually may not want to know—you'll likely find yourself very relieved once you have everything listed out. This will give you a greater feeling of control over the situation. Include the following:
- Who you owe money to,
- How much you owe each creditor, and
- The interest rate on each debt
Now you have to decide which debt you are going to pay off first. Generally, there are two ways to accomplish this:
The approach that will eliminate your debt the fastest is to sort your list by interest rate (highest rate first)—and focus on paying off the highest interest rate debt. When that one is done, concentrate on paying off the debt with the next-highest rate, etc.
The other approach, one that might be more satisfying in the short term, is to sort the list by amount owed with the lowest amount first—and focus on paying that one off. This approach will let you cross something off your list sooner than the first and that may help you stick with your plan. Keep in mind, the first approach will let you cross off all of your debts sooner than the second. People get out of debt all the time and you can be one of them.
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