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.

List Your Creditors Based On Your Selected Debt Reduction Method

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.

Eliminate Creditors From Your List

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.

Additional Resources For Speeding Up Your Debt Reduction

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.

How I Got Out Of Debt – Want to read my story?  Click here and follow the posts from start to finish.