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How to Get Out of Debt

[Jul 9, 2009.]


Making a plan to get out of debt doesn’t always require a visit to a counselor or a service fee to a financial advisor. In most cases, debt relief simply requires changing our relationship with money so that we can use our extra cash to reduce principal. Because squeaky wheels get the grease, it can be tempting to pay off whatever creditors call the most or have the most menacing phone manners. Instead, personal finance experts recommend doling out any “found money” in the following order to get out of debt the fastest:

First, get current on any outstanding home or car payments. When you run out of money before you run out of month, making smaller credit card debt payments first might feel like the right thing to do. In reality, your secured debt requires prompt attention. Credit card debt can’t cause you to lose your home, but a missed mortgage payment can. Any cash left over after bills have been paid and expenses have been set aside should be used to catch up on your major loans. However, personal finance experts note that you shouldn’t get carried away and make extra payments, for reasons that will be explained soon.

Second, pay down your credit card debt starting at the highest interest rate. Experts debate this strategy all the time, figuring that the “big win” of paying off a smaller balance on a lower-rate credit card can give you even more motivation to get out of debt. If you really want to save the most money on interest, pay as much as possible on the credit card that costs you the most. Not only will you cut the amount you spend on debt service, you’ll also shield yourself against overlimit fees.

Third, pay down your student loans. Student loans often get pushed to the bottom in any plan to get out of debt. Although they can be the biggest loans on your balance sheet, they often require the least amount of money to maintain. Today’s student loan interest rates are at generational loans, and many graduates can qualify to consolidate government-serviced loans one time at these low rates. In addition, a variety of assistance, forbearance, and debt relief programs allow borrowers to postpone payments or to qualify for debt forgiveness under certain circumstances.

Finally, find out whether it makes sense to prepay your home or car loans. Many mortgages and auto loans carry prepayment penalties. Other secured loans still require you to stay on the same payment schedule, even if you make extra payments. If it benefits you to pay a lump sum to your lienholder and you already have a sizeable emergency savings account, go ahead and do it. Otherwise, set your excess money aside in a high-interest account that can make automatic bill payments until the completion of your loan term.

Personal finance experts also note that student loans and mortgages should come last on your debt relief list because they often provide tax benefits for borrowers. Financial gurus uniformly offer one more piece of advice: maintaining debt for the perceived value of a credit rating saps your resources and puts you at long term risk of financial collapse. Once you get out of debt, you’ll enjoy a peace of mind and a relaxed relationship with money that fancy homes and cars can’t match.


About Author:

Joe Taylor Jr. is an internal business consultant for a Fortune 500 company, who writes about finance, culture, and design. He holds a Bachelor of Science in Communications from Ithaca College.

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