If you are in debt, you are not alone. Americans owed more than $2.5 trillion in consumer debt as of February 2012, according to the Federal Reserve, and that amount is growing at an annual rate of approximately 4.25 percent. Debt is certainly easier to get into than to get out of, and if you ever get behind, it can be a nightmare. Fortunately, if you have a regular income and a plan, you can pay down your debt without going broke.
Create a realistic budget. If you don't know how much money you bring in each month and you can't tell where the money goes, you have a very dim chance of ever getting out of debt. A simple budget has two columns. List all of your monthly income from all sources in the left column. List all of your monthly living expenses and debt payments in the right column. Total up both columns and subtract your expenses from your income. If your income in greater than your expenses, you have positive cash flow that you can use to pay down your debts. If your expenses are greater than your income, you have negative cash flow and you will need to make some adjustments to the budget.
Examine your budget to find areas where you are overspending or that you can cut or reduce. Perhaps you spend too much money eating out. Maybe you can drop the sports package on your cable bill. If you can't find sufficient cuts in your expenses, your only other option is to increase your income. You may need to find a better paying job, or to take a second job until you can pay down your debts to a manageable level.
Create a debt list. Divide this list into three columns. In the first column list the names of each person, company and organization that you owe money to in descending order, starting with the the greatest amount of debt to the least amount of debt. Next to the name, list the total amount you owe. In the final column, list the amount of your minimum monthly payment.
Make minimum payments on each of your debt obligations each month. If you are behind on any of your obligations, get them caught up before trying to pay off any other debts. Late fees and penalties will kill your budget. Place any excess funds after you've made your minimum payments into a savings account to create an emergency fund. The proper amount of your emergency fund is different for everyone. Financial adviser Dave Ramsey recommends keeping three to six months' worth of living expenses in savings with a minimum of $1,000. The website getrichslowly.org advocates keeping 10 percent of your annual income in savings. A grand in savings will help you cover unexpected expenses, such as replacing the tires on your car or replacing your worn-out washing machine. Three to six months of living expenses will help cover you if you lose your job.
Implement a debt snowball program once you have your emergency fund in place. Continue making minimum payments on all of your debts, but instead of putting your excess funds into your savings account, use them to pay extra on one debt until you pay it off. Once that debt is paid off, roll the amount you were paying into the payments on another debt. As each debt is paid, you will reduce the amount of interest that you are being charged each month and you will have more money to pay on the larger debts. There are two schools of thought regarding which debt to pay first. ABC News consumer correspondent Elisabeth Leamy advocates paying off the debt with the highest interest rate first, to save money on interest. Ramsey recommends attacking the debt with the lowest balance first, to create a psychological attitude of victory. Choose the method that works best for you and stick to it.
- Always give yourself some fun money in your budget to spend on whatever you want. This will help keep you from blowing your budget.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.