Step 1: Stop Using Your Credit Cards!
More than a third of Americans are putting off their life savings because of credit card debt. This situation quickly escalates as people open new credit accounts to pay off other cards or cover basic necessities. It may seem impossible to imagine your life without credit, but you absolutely must stop charging to get out of debt!
One way to eradicate temptation is to cut up your cards. Don’t call to close your account, which could lower your credit score even further -- but rather, get rid of the urge to splurge. Less dramatic credit card owners will lock their plastic in a safe or lock box. If you find yourself spending on frivolous things while out and about, leave your cards at home. More importantly, you must find the leak in your budget and plug it. Are you overspending on shoe shopping, eating out or spending too much on one of your bills? Once you’ve gone a month without using your card, treat yourself: a massage, a dinner out or a new outfit will ease your woes, without breaking the bank.
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Some families struggling to budget use an envelope system, where they set aside physical money in envelopes labeled in various categories – rent/mortgage, bills, entertainment, groceries, savings, etc. Once the money runs out of the envelope, they’re done with that area of spending. This is a great way to practice discipline.
Step 2: Track Your Cash
Tracking your monthly expenses is the best way to find the leak in your budget. Perhaps you haven’t been all that organized in the past and the amount of half-opened mail on your desk exceeds your work. You’ve never saved receipts or written down expenses in a check book before. For many Americans, their stubborn refusal to fess up to the situation is half their problem.
Start saving all your bills for the month, sit down and write out everything that you owe: mortgage/rent, cell phone bill, utility bills, cable bill, insurance expenses, car loans, prescriptions, fuel to commute to work, grocery budget and minimum monthly payments.
Then save your receipts diligently and write down each expense throughout the month. Often ways to save will illuminate themselves – whether it’s quitting smoking, not eating out so much or curbing compulsive shopping. In other cases, it could be the large expenses that get you – the vacations, the home repairs, the auto repairs, mortgage expenses or the college tuition bills – in which case, you’ll need a better saving plan and more restraint in spending money you haven’t planned on.
Step 3: Make a Budget
There are numerous approaches to budgeting that vary from expert to expert. As a general rule, you shouldn’t be spending more than 33% of your income on your housing. Your expenditures on things like coffee, alcohol, cigarettes, charity, books and personal care products/services should all be less than 3% of your monthly income for each category. You should never spend more than 5% of your income on any of the following: entertainment, out-of-pocket health care, clothing/dry cleaning or as a balance on your credit card. Your household transportation should cost less than 15%, your food budget 15% and your retirement 9%. These are just ballpark guidelines to help you spot budget leaks.
Richard Jenkins of MSN Money Magazine recommends using the 60% Rule, which says that 60% of your household income will be set aside for your committed expenses, including: basic food and clothing needs, insurance premiums, charitable contributions, all bills, all taxes and essential household expenses.
For the remaining 40%, you should set 10% aside for retirement savings; 10% for long-term savings; 10% for irregular expenses (holidays, repairs, vacations, new appliances); and 10% for fun money. If you’re in substantial credit card debt, then use the 20% allotted for retirement savings and long-term savings and use that to pay off your credit debt.
If setting aside 60% seems impossible, you need to ask yourself the hard questions: Can you afford the private school your kids are in? Is the house too big? Can you really afford those boat payments, the car payments or the motorcycle insurance? The secret to budgeting is being honest with yourself and creating a long-term system that works for you.
Step 4: Boost Your Income!
The easiest way to pay off your debts is to have an extra cushion of income behind you. This may seem easier said than done in this economy, but a little effort can go a long way and there are a number of efforts that pay off. In some cases, it’s a big change – like finding a higher paying job, taking a second job waitressing, bartending or factory working. It could mean two heads of the household working instead of one. Perhaps you can ask your boss for a raise, seek a promotion or work more over-time.
Or it could mean turning a hobby into a lucrative moneymaker. Are you good at photography, writing, knitting or creating websites? These are all excellent sources for secondary income streams. Sometimes you can take your skills or knowledge from work and do some independent consulting from your home in your spare time. Or you could do little things: sell your stuff on Craigslist, eBay or Fusion Cash; have a garage sale. Look into your credit card rewards and see if you’re owed any cash back.
Step 5: Start Paying the High Interest First!
Financial wizards like Dave Ramsey recommend paying off your smallest debts first to create a “debt snowball effect,” where you feel more and more motivated to continue paying off your debts. However, conventional advice says that it makes more sense to tackle those high interest credit cards first, since you’re amassing thousands of dollars in meaningless debt each year. Make sure you pay the minimum monthly balances on all your cards each month to keep your credit score afloat. Then start aggressively paying down the highest interest rate balance until it’s paid off and you can move to the next card. In some cases, your creditors may be willing to lower your interest rate when they see the “new you” making a valiant effort to pay off what you owe responsibly.
If you’re having trouble with any of these steps, you may want to enter into a debt management plan, credit counseling, a debt settlement or a debt consolidation as viable alternatives to bankruptcy.
Techniques for Negotiating with Creditors
Negotiating with creditors is another way to save money. If you’re normally diligent about paying your cards off, you can usually speak to someone who will sympathize with you and agree to waive a late fee, give you an extension on your deadline, change your deadline to a more suitable day or even drop your interest rate. Explain your situation clearly without making a big production out of it. Simply state why you’ve faltered on your most recent payment, while also mentioning your intention to pay back what you owe. Let them know how much you can afford to pay. If one person denies you, ask to speak with a supervisor. Know the Fair Debt Collections Practices before you call.
If you’ve been far behind in your payments for a while now, your best bet is to negotiate with a lump sum of cash. Wait for that tax return, save up a reserve or sacrifice for a few months to get $1,000 or more to drop down at once. You can often convince your creditor to knock the total amount of debt down to 50-70% of what you owe! It’s very important that you know your rights and do not feel pressured in this situation. It’s common for creditors or debt collectors to try to take money directly out of your bank account while you’re still on the phone. And it’s your legal right to ask for the agreement in writing before making any payments.
Caution: Minimum Payments Lead to Debt!
It’s shocking to many people that those nice “minimum monthly payments” are actually traps to keep you bogged down in debt for life! This enticement to get Americans living outside of their means is dangerous and should be avoided at all costs. For instance, if you owed $5,000 on your 14% interest rate credit card, and you just made your $75 minimum monthly payments, it would take 128 months to pay off your balance! Not to mention it would have an overall cost of $9,600 ($4,600 in interest). There are many ways to save on interest if you are committed to paying off more than the minimum monthly payment each month. You may want to check out a credit card payment calculator to determine the best way to pay off your debts.
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Tips for Boosting Your Credit Score
Once you’re out of debt, you can focus on being more responsible and creditworthy. This will help you buy a house, a car, get out a loan in the future or just feel better about yourself.
- Tip 1: A whopping 35% of your credit score is based on payment history. So never miss a payment and never pay late!
- Tip 2: Another 30% of your score depends upon how much money you owe. So look at your credit limits and work on getting your balances down to less than 30% of what’s been offered to you!
- Tip 3: The length of your credit history comprises 15% of your score. So do not close out old longstanding credit accounts! Otherwise, creditors will see only your most recent accounts. By closing accounts, you will also decrease the amount of total credit available so it will look as though you’re using a bigger percentage.
- Tip 4: Types of credit accounts for 10% of your FICO. So try to have a few credit cards and an installment loan (mortgage, car, personal) on your account! You can even borrow a loan out against yourself from your savings account and pay yourself back each month. That will show you’re capable of making a plan and sticking to it, therefore will be reported to the credit bureau as positive information!
- Tip 5: Lastly, 10% of your credit score is comprised of new credit requests. Don’t go hog wild taking every credit offer that’s sent to you! Opening several new credit accounts in a short period of time will make you look like a risky borrower, so beware!
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