Friday, April 1, 2011

Baby Step:4 Paying Off Credit Card Debt

We have covered budgeting over the last few posts.  Hopefully you all have a budget in place and are starting to reap the benefits of your money working with you and for you, instead of your money working you.

Today we are going to discuss the next area in baby big dreams, and that is paying off your debt. When your debt will be paid off completely depends on many factors, unique to your situation.One thing is sure, if you are persistent in paying down your debt and do not acquire new debt, in time you will be debt free. That is the goal you must keep in front of you.

 As We have talked in the past, it doesn't make a lot of financial sense to have a large savings account, if you are paying off high interest credit card debt every month. However, you should have an Emergency plan in place. Your Emergency fund is the first thing you should fund even before paying off your credit card debt. If you missed that post you can read it here. Your emergency fund allows you to stay on budget, when the unexpected happens.

Once your Emergency Fund is fully funded  (On average $1000), You can start your credit card payoff. First make a list of all your unsecured debt. Unsecured debt typically carries a much higher interest rate. An example of  Secured debt would be a mortgage.

Make a list of the balance on each card, the minimum payment due each month, and the interest rate you are being charged
Start with the highest interest rate,... say 19.9%
 Make your monthly payment & any extra money you receive is placed on the highest interest rate debt. Continue making all your other payments on time
When you get any extra money, overtime, birthday money, Income Tax.....
add it to the scheduled payment
Say your payment is $50, you made an extra $30 at work this  month, you now make an $80/payment
When the highest debt is paid off (this goes faster than you might think)
you now take the $50 you were paying on the first debt and add that to the second debt

Scenario looks like this:
Debt #1 paid off
 Apply payment from Debt #1 and add it to debt #2 Second Highest Interest Card
Debt #2 Paid off
Now you take what you were paying on Debt #1 & Debt #2 and apply to Debt #3
So lets say Debt #1 is $50.00/mo &; Debt #2 is $60.00/mo
The Scheduled payment for debt #3 is $80.00/mo
Your new payment for debt #3 after Debt 1&2 are paid, is

Or if you spend $500.00 per month in debt reduction you continue paying $500.00 until all debt is paid. The key here is when you start to pay down debt, that you do not take the freed up money and spend it, or worse yet acquire new debt. Just because you have paid some debt down does not mean you now have "extra" money, especially if you still have more debt.

This is known as the Snowball effect and it is very effective in helping you reduce your debt.
Remember all this debt did not happen overnight and will not go away overnight. Our goal is to stay focused and remember we are taking baby big dreams!!