Debt Reduction 101 – Beginner’s Guide To Debt Reduction

Debt Reduction 101 – A Beginner’s Guide To Debt Reduction

Calculate How Much Money You Have On Hand

Checking Account:_______________

Savings Account:_______________

Wallet:_______________

Piggy Bank:_______________

Etc:_______________

(Exclude Retirement Accounts)

Total On Hand:_______________

Establish An Emergency Fund Minimum Amount

An emergency fund is your line of defense against the unplanned expenses of life.  Many popular authors and commentators suggest a minimum Emergency Fund amount of \$1000.  Others suggest \$500 per family member.  Establish an amount with which you are comfortable, and keep that amount of money in your savings, at all times, throughout your debt reduction process.

Emergency Fund:_______________

Calculate How Much You Have Available For Immediate Debt Reduction

Total On Hand – Emergency Fund = Available For Debt Reduction:_______________

If the calculation above results in a negative number, you need to build your emergency fund before you begin to reduce your debts.  Continue to make minimum payments to your creditors, and focus on building your emergency fund.  Once your emergency fund has been established, move forward with your debt reduction process.

If the calculation above results in a positive number, you have money available for immediate debt reduction.  Congratulations.

Create A List Of Your Creditors (Balances, Interest Rates, Minimum Payments)

Credit Card 1:__________     Interest Rate:__________     Minimum Payment:__________

Credit Card 2:__________     Interest Rate:__________     Minimum Payment:__________

Credit Card 3:__________     Interest Rate:__________     Minimum Payment:__________

Automobile 1:__________     Interest Rate:__________     Minimum Payment:__________

Automobile 2:__________     Interest Rate:__________     Minimum Payment:__________

Student Loan:__________     Interest Rate:__________     Minimum Payment:__________

Other Debt:__________     Interest Rate:__________     Minimum Payment:__________

(Include or exclude first mortgage debt)

Calculate Total Amount Of All Debts

Total Debt Balance:_______________

Decide Which Debt Reduction Method Works Best For You

There are several popular debt reduction methods, but they all work on the same principle – momentum.  Imagine that, instead of several small debts, you have one big debt, which you just calculated.  Your goal is to eliminate your Total Debt Balance.  To do this, you need to have a plan in place, a plan that works for you.  Remember, you goal is to eliminate all of your debt, not just a balance here or a balance there.

If you want to ensure that you pay, over time, the smallest amount of interest, then reorder you list of creditors by interest rates.  Put the creditor with the highest interest rate on top, the creditor with the next-highest interest rate second, and so forth.  Over the long run, this method, if followed correctly, will be the most mathematically sound.

If you want give yourself the emotional boost that comes from quickly eliminating a creditor or two from you list, then reorder your list of creditors by account balance.  Put the creditor with the lowest balance on the top, the creditor with the next-lowest balance second, and so forth.  Over the long run, this method, if followed correctly, will cost a bit more than the previous method, but watching those first two or three creditors disappear can be very rewarding, psychologically and emotionally.  This is the method that I used when getting out of debt in 10 months.

If you want to eliminate creditors based on how much they bother you, regardless of balance or interest rate, reorder you list of creditors using your very on this-debt-bothers-me scale.  Put the creditor that bothers you the most on top, the creditor that bothers you just a little less second, and so forth.  This method works best for those who owe debts to the IRS or family members, and just want to see those debts gone!

If you are behind on a particular account, by all means, move it to the top of the list.

Credit Card 1:__________     Interest Rate:__________     Minimum Payment:__________

Automobile 1:__________     Interest Rate:__________     Minimum Payment:__________

Student Loan:__________     Interest Rate:__________     Minimum Payment:__________

Credit Card 2:__________     Interest Rate:__________     Minimum Payment:__________

Other Debt:__________     Interest Rate:__________     Minimum Payment:__________

Credit Card 3:__________     Interest Rate:__________     Minimum Payment:__________

Automobile 2:__________     Interest Rate:__________     Minimum Payment:__________

Begin To Live On A Budget

I added this section after publishing this guide.  If you are not living on a budget, start now.  I’ve written extensively about this subject, including the following articles:  How To Create A Budget With Irregular Income, 10 Ideas For Creating A Better Budget, and Creating A Basic Budget.  Needless to say, which is why I left this part out of the guide at first, if you are not living on a budget, you cannot get out of debt.

Stop Using Credit Cards And Accumulating Debt

Again, after publishing this guide, I felt the need to go back and add this section.  If you are trying to get out of debt, the last thing your need to do is borrow money.  Stop using your credit cards and start paying off your balances.  If you absolutely must use a credit card while getting out of debt, something I strongly urge you not to do, please use a card that you can pay off, in full, at the end of the month.

Make Minimum Payments To All Creditors

Never miss a minimum payment and always make minimum payments on time.  For credit cards, your minimum payment can be found on your monthly statement.  For automobile loans and other installment, your minimum payment is your monthly payment.

Send Extra To The First Creditor On Your List

You have already calculated how much money you have on hand for immediate debt reduction.  Send that amount to the first creditor on your list.  If you have enough to completely pay off your first creditor, great!  If you still have money left over after eliminating your first creditor, send that money to the next creditor on your list.

When sending extra payments, feel free to send one check, with your minimum payment plus extra payment, or, send two checks, one for the minimum and one for the extra payment (marked apply to principal).  Contact your creditors and ask them how they handle extra payments / payments above the minimum.  You do NOT want to prepay your automobile loan, for instance, you want to PAY DOWN your principal.  Use online banking to eliminate postage.

Each month, continue to send minimum payments to all creditors and an extra payment to the creditor on the top of your list.  Eventually, you will begin to eliminate creditors from your list, by paying off entire account balances.  This is where the fun begins.  Combine the minimums that were going to creditors no longer on your list, and apply those minimums, along with your extra payment, to the next creditor on your list.  Continue this process of eliminating creditors, applying old minimums and the extra payment, until you are debt free!

If you want to speed up the process, consider sending more than one extra payment, each month, to the account at the top of your list.  These micro-payments will keep you engaged, throughout the month, in the debt reduction process.  Each daily financial decision, big or small, will impact how much extra you have for debt reduction.  Sending a micro-payment of \$10 will encourage you to skip the restaurant and brown-bag-it for lunch.

Debt Reduction Guide – An easy-to-follow guide to debt reduction – complete with advanced tips and techniques.

Debt Reduction E-Book – An 8 page, free-to-download guide to debt reduction.  PDF

Illustrated Guide To Debt Reduction – For those, like me, who are visual learners.

Illustrated Debt Snowball – Exactly how the debt reduction method works.

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8 thoughts on “Debt Reduction 101 – Beginner’s Guide To Debt Reduction”
1. Eric J. Nisall

This is by no means a citicizm of your reduction form, but I did notice two items that are missing. Debt reduction begins with understanding cash inflows and outflows. The difference between thetwo is the amount that is left for reducing debt. Without taking into account inflows and outflows to/from all all sources, no debt reduction plan would be complete, because, if there is no money left over from payments of fixed expenditures (food, utilities, gas, etc.) then the debt will not get reduced. In my personal experience, developing a budget and reducing eliminating costs is the first step, especially when attempting to take an aggressive approach to reducing debt. Once the budget is set and analyzed for all possible cuts in spending, then the reduction strategy should be undertaken. Again, this is just meant to enhance the effort to get out of debt, while gaining a new understanding of budgeting and planning.

2. Mike Nash

This is a great article – one suggestion is to find an online calculator or software that could do the job. Doing is by hand is to painful.

3. The Happy Rock

Nice guide NCN.

I think changing one’s mindset to not to use debt, freezing or cutting up the cards, not using HELLOC, not getting cars loans is critical. If you don’t shutoff the water you can’t stop the leak.

4. Dana

What should one do when you can’t make the minimum payments? I have talked to the credit card companies and they won’t do anything until I can tell them when I can pay. My husband is commission only so I really can’t tell them. It’s turning into a nightmare for me. I am trying very hard not to worry over it.

What hurts most is that I was on a good plan for paying everything off. Had my spreadsheet and snowball going…then I lost my job. I can’t seem to get it back on track now that I am back to work.

5. San Francisco Financial Planning

Lovely advice. Also, don’t forget to make it a regular practice to call your credit cards to ask for a lower rate. I have one client who owes over \$20,000 on a Visa that was at 18%. He spoke with a ‘rate specialist’, touting his rising credit score and declining balance and got his rate cut in half, from 18% to 9%! His monthly interest charge was instantly reduced by \$150, which will help him pay off his debt even sooner. The method described above is the best way to get our of credit card debt, but you might as well make it even easier to see if you can lower those interest rates!

6. Jane Swire

Glad you weren’t hurt or your daughter with the deer accident. Congrats!!!!!!!!!!!!! on your weight loss I’m rooting for you. I am now maintaining my weight and its challenging.
Love your articles keep them coming.
Jane 🙂

7. Nick

One thing I’ve got to stress, is just make sure you pay as much as you can to your debts with the highest interest. Sure it would look nice to eliminate some off the list if they have small balances, but it does not make sense financially. Interest rates can kill you if you let them.

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