Rethinking Retirement  
 

Debt Reduction Strategies

12 Steps to Paying Off Debt

Two of the most common questions asked of financial advisors are, "Should I pay down my debt or begin to save more?" and, "How do I go about paying down the debt that I have?" 

It's no longer uncommon to see people of all ages struggle with mounting debt and dwindling savings. To reverse that trend takes a lot of hard work and tough choices, but is doable if you follow these 12 steps.

1.  Make sure your cash flow is balanced so you do not continue to accumulate debt.   Balancing your cash flow often requires difficult choices but is critical to financial maturity. For more information, see Understanding Your Personal Cash Flow Statement. 

2.  When your cash flow is balanced, make a list of all your debts including: 

- Creditor

- Balance owed

- Interest Rate

- Monthly Payment amount

  3.  Total the monthly payment column to determine how much you're paying each month in total debt service. Even after steps 5-8 we will try to keep the amount dedicated to monthly debt service the same as you have now.
 
 4.  Group your debts into short-term (those that can be paid off within six months,) intermediate-term (those that will be paid between 7 and 60 months) and long-term (those that will take more than 60 months to pay.) 

5.  If there are any debts with small balances that can be paid off in the next 3-4 months, keep those separate and work to pay those off as quickly as possible. This will help your credit score and loosen up cash flow that can be applied to other payments.

 6.  Explore consolidating any intermediate- or long-term debts that carry high interest rates into one lower interest loan. Your goals in doing this are to reduce your interest rates and the total amount of your monthly payments. However, be careful not to lower your payment purely by extending the length of time it will take to repay the loan. 

7.  When you have finished grouping and consolidating your debt, you should be able to categorize each debt as short-term, intermediate-term or long-term, and all should have reasonable interest rates.

 8.  Focus first on paying off your smaller balances. When you completely pay one off, take the payment amount that you had been paying and add that to the next smallest balance. By paying that much extra each month, you will pay the next loan off that much quicker. Continue to "snowball" your payments like this until all of your short-term debts are completely paid. 

9.  Take half the amount you were paying on your short term debts and begin contributing that to an emergency fund savings account.

 10.  Take the other half of what you were paying to service your short-term debt, and add that amount to the monthly payment of your smallest balance intermediate-term debt. When one is paid off, continue to "snowball" these payments by applying the amount of the now-paid debt to your next lowest balance payment. Continue this process until all intermediate term debts are paid.
 
11.  Again, take half the amount you were paying toward your intermediate term debts and begin to contribute that to savings and investments.
 
12.  Apply the other half of your intermediate term payment toward paying down your long term debt in the same fashion as before.
 
By following these 12 steps and diligently exercising financial discipline, you can eliminate your debt and begin to build a solid financial foundation.
 




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