Three Simple Steps to Debt Reduction

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3 Debt Reduction Tips

As the basic costs of living have continued to rise, more Americans are falling into debt. If you're one of them, you may think there's no hope for the future. But there is. A debt reduction plan is all you need to free yourself from debt for good. Also, if you are a home-owner, in addition to following these tips you should always explore getting a mortgage refinance.  Follow these three steps to start reducing your debt today.

Debt Reduction Step 1: Stop Creating Debt

Pay cash for regular expenses like groceries, gas, and utilities. Using a debit card is okay, as long as the money is in your checking account. Your goal is to avoid paying interest on your daily expenses and to avoid increasing the balance on your cards. Once you have a balance, every charge will carry interest, even if you pay that portion of the bill at the end of the month.

Before making a purchase, consider whether it's a need or a want. For example, groceries, heat, and new shoes for your growing child are necessities. $200 designer sneakers for your trend-following teenager are not. Of course, you shouldn't skip necessary car maintenance and medical appointments to save money. It's usually cheaper to solve a problem in the early stages than to wait until it's much worse.

Debt Reduction Step 2: Calculate Your Expenses and Debt

You don't need fancy software to create a debt reduction plan. All you need is paper, a pencil, and a calculator.

1. List all your monthly must-pay expenses: rent or mortgage, auto expenses, groceries, insurance, medical expenses, student loan payments, childcare, utilities, tuition, and minimum debt payments.
2. List all your sources of income and how much you receive on a monthly basis.
3. Subtract your expenses from your income. The difference is how much you can put towards reducing debt. If your expenses are more than your income, see step three.
4. Make a chart that lists the name, balance, interest rate, and minimum payment for each debt or loan.

With these three lists in hand, you can create your debt reduction plan. You have two options to quickly reduce debt: pay off the smallest balances first or pay off the highest rate debts first. The highest rate plan may save you a small amount over the smallest balance plan, but paying off a small balance quickly might be the motivation you need to keep going. The key to success is your commitment to paying as much as you can every month. If you can pay off any one balance in full right away, do it now.

If you pay the smallest balances first, pay only the minimums on your other debts. Once that debt is paid off, move onto the next one, but pay both the large payment and the minimum payment. This is called a debt snowball. By the time you reach the last debt, you'll have worked up a large payment that will pay off your final debt quickly.

If you pay the highest rate debts first, pay as much as you can to the highest rate debt and the minimums on the rest. When that debt is paid off, apply those payments plus the minimum to the next highest-rate debt.

Many people with high interest rates apply for debt consolidation loans or balance transfers to 0% cards. Either option will significantly reduce your interest rate, allowing you put more of your payment toward the principal. Just make sure that you can either pay off the debt or transfer it again before the interest rate rises.

Debt Reduction Step 3: Change Your Spending Habits

People who permanently eliminate their debt also change the way they view money. Rather than going into debt trying to keep up with their friends and neighbors, they see money as a tool to help them achieve their own goals. Instead of acquiring stuff that impresses other people, worry about how you feel about yourself. Being debt free will make a lot happier than the biggest TV in the world would.

Student Debt Plan

If you're in school and want to establish a debt reduction plan before you have to start paying it off, check out our student debt management guide.

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