Showing an interest in reducing your debt is a big step. Let one big step lead to another by finding out how to put together a plan to eliminate your debt.
When you're overloaded with debt, it can be difficult figuring out how to best tackle the debt. You have to figure out which accounts you should pay, in what order you should pay them, and how much you need to pay to eliminate your debt. By attacking each of these hurdles one by one, you can tailor a plan that fits your budget and debt load.
Calculate Your Total Debt
To make a plan for getting out of debt, the first thing you need to do is figure out who and how much you owe. Start by getting a copy of your credit report. Your report will contain all of your financial obligations from institutions that report to the major credit bureaus. Your credit report might not contain all your debts, so you should also use recent statements from your creditors to complete your list.
On a single sheet of paper write down the name of each creditor, total amount owed, monthly payment, and interest rate for your accounts. Depending on your goals for getting out of debt, you may want to consider only bad debt, such as credit cards and small loans.
Your list, for example, might look like this:
- Visa credit card, $780, $47, 11.9%
- Macy’s credit card, $1515, $89, 18.9%
- Bank of America loan, $900, $55, 7.8%
Prioritize Your Creditors
Once you have a complete list of your debts, you should figure out how you want to pay them.
When it comes to the cost of having debt, the best way to pay your debt is by paying off those with the highest interest rates first. Rank your debts in order from highest to lowest according to interest rate. This is the order you’ll repay your debts.
As an alternative, you might consider paying off your smallest debts first. If your high interest debts also have high balances, you could end up paying on a single account for months before the entire balance has been repaid. Since smaller debts are repaid quicker, many people prefer to pay them first.
You should choose the method that will keep you motivated to pay off your debts. If optimizing your payments is most important, then the high-interest method is best.
Determine How Much You Can Pay
Another crucial component of your plan to get out of debt is the amount you can afford to pay on your debt each month. To come up with this amount, you need to figure out your discretionary income. This is the amount you have for spending after all your financial obligations have been met.
Total your income from all reliable sources including wages, alimony, child support payments, bonuses, or dividends. Then, subtract what you spend each month on required expenses, those items you need for survival. Required expenses include mortgage or rent, utilities, food, transportation, medical expenses, and your current debt payments. This calculation will result in your disposable income.
With your disposable income in mind, you can figure out how much you are able spend to repay your debt each month.
Make the Plan
Now you that know how much you will be spending to pay off your debt, you can complete your plan. Put all of your debt-spending money towards your highest priority debt. This will either be your smallest debt or the debt with the highest interest rate, depending on the method you choose. Pay this amount plus the minimum payment every month until the debt has been completely repaid. Continue making the minimum payments on your other debts.
Once you've paid off the first debt, combine the minimum payment from that debt with the extra amount you’ve allocated for repaying your debts and put it towards the debt with the next highest interest rate (or next smallest balance). Repeat this process until your debts have been completely repaid.
Let’s say you’ve decided to spend an extra $300 each month to repay your debts. Using the previous example, you should start with the Macy's account because it has the highest interest rate.
1. Macy’s credit card, $1515, $89, 18.9%
2. Visa credit card, $780, $47, 11.9%
3. Bank of America loan, $900, $55, 7.8%
Each month, make a payment of $389 ($300 plus the minimum payment) until the debt has been repaid. Even though your minimum payment will decrease as you pay off the balance, continue sending $389. The same goes for your other debts, too.
Using the example from above, your plan will look something like this:
• Macy’s: $389
• Visa: $47
• Bank of America: $55
Once you have repaid Macy’s you should repay Visa, the account with the next highest interest rate.
Your payment should be $436, the $389 you were paying to Macy's plus the $47 you were already paying to Visa.
Update your plan.
• Visa: $436
• Bank of America: $55
Finally, when you have repaid the Visa account, use all $491 to repay the Bank of America loan.
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