When you were a kid did you ever have one of those clown bop bags where no matter how many times you hit the clown it just popped right back up? Does fighting with debt feel a lot like this to you? Do you keep punching away at your debts but they just keep popping back up? If this is the case it’s possible that you need to forget about struggling to pay off individual bills and think more in terms of debt management or how to get your debts under control and ultimately gone for good.
Where it all starts
The first step to effective debt management is to evaluate your debts. You may have never thought of it this way but there are actually good debts and bad debts. Good debts are those that have low interest rates and represent things that will increase in value over the years. The best example of good debt is a home mortgage. Your mortgage loan probably has a low interest rate and your house will grow in value over the years to come. Your automobile loan could also be considered good debt because it was used to finance something useful and probably has a decent interest rate. Credit card debts are bad debts because they will just basically suck money out of you without providing anything in return. Plus, credit cards will cost you more money as they generally have interest rates that can be as high as 19% or even higher.
Why is it important to know the two different kinds of debt? It’s because you can take your time paying off good debts but you should do everything possible to pay off bad debts as quickly as you can.
A second part in evaluating your debts is to calculate your debt-to-income ratio. This is a simple piece of math as all you have to do is divide your total monthly debt payments by your monthly income. For example, if your monthly debt payments totaled $2000 and you monthly income was $4000, your debt-to-income ratio would be 50%. Most experts say your debt-to-income ratio should be 20% or less. So if you were to learn it was 40% or 50%, you can see that you have some hard work ahead of you.
Choose a repayment program
The second step in debt management is to choose a repayment program. If you calculated your debt-to-income ratio and it was above 30%, your best option might be to go to a credit-counseling agency for help. When you do this, you will be assigned a counselor who will review all of your debts and expenses and help you find ways to cut your spending. If you are able to reduce your spending to the point where you have something of a cushion you could then choose either the ladder or the snowball method for repaying your debts. The ladder method is where you stack your debts from the one with the highest interest rate down to the one with the lowest and then focus all of your efforts on paying off the highest interest debt first. The snowball method means organizing your debts from the one with the lowest balance down to the one with the highest and then focusing on paying off that debt with the lowest balance. The advantage of the ladder method is that it will save you the most money though it will take you longer to pay off that first debt. In comparison, with the snowball method you should be able to get the debt with the lowest balance paid off fairly quickly, which will give you the incentive and momentum to start paying off the debt with the second lowest balance and so on. Of course, whichever of these you choose it’s important to continue making at least the minimum payments on your other debts.
Step three means organizing all of your bills and any other important financial documents. The easiest way to do this is by creating separate file folders for categories such as utilities, mortgage, credit cards, auto loan or loans, insurance and so forth. This will make it much easier for you to keep track of your debts and to keep on top of how much you owe. This should not take you much time and will save you a lot of brain damage in the future. Wherever you keep all those folders you should also have a calculator handy.
Next, create a spreadsheet of your debts. You will then have all of your debts, interest rates, minimum payments and due dates altogether in one place, which will make it much easier to begin repaying your debts whether you choose the ladder or snowball method. You adjust these numbers each month as this will help you visualize where you stand and see the progress you’re making.
Talk among yourselves
Debt management shouldn’t be a one man or one woman task. If you have a spouse or partner it’s important that the two of you communicate so that the both of you will understand your debt management program and any changes you will need to make in order for you to become debt free. It can be challenging if you have a spouse or partner with whom you will need to deal. You will need to work together to determine one another’s financial strengths and weaknesses. This can help you avoid conflict and disagreement so that your journey to becoming debt-free is one that you both share.