Stop the bleeding
It's the first thing they tell you to do in the event of a life-threatening injury, and the same rule holds true when your financial survival is on the line. If you've got so much cash flowing out to creditors that you can't meet your basic needs with what's left and the possibility of bankruptcy is looming, step one toward recovery is to stop adding to that debt.
For some people, the quickest way to curb spending is to become a cash-only consumer, says Scott Stratton, president of Good Life Wealth Management in Dallas.
"It can be shocking, but it's very effective," Stratton says. "If you give yourself $200 a week to spend on all your groceries and gas, then if you use that up in four days, you'll just have to cope for a couple of days."
If your credit score is in good shape, a balance transfer to a lower interest rate credit card might be worth considering, Stratton says. But if your credit history has you on shaky ground, you might want to look into a debt consolidation loan or negotiating a payoff plan with your credit card issuers.
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Imagine your debt-free life
If you're feeling like the guy in that old TV ad who's lamenting, "I'm in debt up to my eyeballs," it may be hard to see a solution and even harder to move past your anxiety to implement it.
McClary suggests trying a little visualization therapy. Picture yourself debt-free.
- How would you feel?
- How would you live?
- What longtime goals would you be able to accomplish?
You may be wondering whether you should spend time daydreaming when you might be getting a collection agency letter any day now, but McClary insists this exercise isn't trivial.
"A lot of people brush that off and say, 'That's fluff,' but that's what's going to keep you motivated through what may be a long and difficult process," McClary says.
Conduct a full-budget checkup
So you've put the credit cards away, done whatever you can to lower the cost of your existing debt and found a long-term goal to motivate you along your debt consolidation journey.
Now it's time to take a thorough review of your budget. Track every dollar coming in and going out so you can get a realistic idea of how much you can pay against the debt.
Thomas Nitzsche, a credit counselor and media relations manager for ClearPoint Credit Counseling Solutions in Atlanta, says many of his clients are surprised when confronted with their true budgets, because they have relied so long on credit cards to stretch their spending capacity.
"When they cut themselves off of that line of credit … they often don't have as much as they think they do to begin repayment," Nitzsche says.
McClary advises following the 50-20-30 rule of budgeting: Allocate up to 50% of your budget to fixed expenses like mortgage, rent and car payments; 20% to savings; and 30% to variable expenses, especially discretionary spending for things like hobbies, recreation and dining out. That 30% zone is the first area to target for cutting back, McClary says.
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Climb down the debt ladder
Let's say you've trimmed your budget enough to pay significantly more than the monthly minimum on your credit card bills. You can either apply the extra payments evenly across all your accounts or choose a payback strategy that focuses on paying off one or two accounts first before moving on to the others.
To get out of debt using the ladder method, start by attacking the balance on the account that charges the highest interest rate, McClary says. While you're ramping up payments on that account, you make minimum payments on the others. When your highest-interest balance is gone, you move down a rung of the ladder and apply all your extra payments to the account with the next highest rate. You repeat the process until all your debt is eliminated.
"The ladder method is often touted as the one that saves you the most money over the long term because you're getting those high interest rates out of the way first," McClary says.
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Build a repayment snowball
The other common strategy for paying off debt is called the snowball. In this method, instead of using interest rates to determine which account to pay off first, you focus on the size of balances. You start by putting extra money on the account that has the lowest balance and, once it's paid off, shift the funds to the next one up.
Targeting your lowest balance first means you're likely to get to a zero balance sooner than you would using the ladder method.
"For people that need to see instant results to keep them motivated, that may be the best process for them because it's the quickest way to get them to a successful conclusion," McClary says.
Ask your creditors for help
Yes, really. Nitzsche says that while many credit counseling clients admit to dodging collection calls, they often don't realize that creditors are usually willing to work with them, especially if they are dealing with a financial hardship. Explaining that you are unemployed, earning lower wages or facing the cost of a medical emergency may result in an offer to waive your interest rate temporarily, he says.
McClary says the best time to go to creditors for help is before the situation is out of control. Don't wait until an account is about to be closed because you've had several months of late or missed payments. Tell the creditor you'd like to pay down your balance faster and want to know what services are available to help you manage your debt better.
"Those are conversations that, having been on the creditor side of the call, I can tell you don't take place enough," McClary says.
Consider credit counseling
If you can't seem to come up with a viable debt elimination plan on your own -- with or without your creditors cutting you some slack -- turning to a nonprofit credit counseling agency may be the answer. These organizations provide services either free or at low cost to help clients get out of debt.
A professional credit counselor can help you review your debt situation and identify repayment options and money management techniques that you may not have thought of on your own, McClary says. Nitzsche notes that once a credit counselor helps you devise a repayment plan, he or she will usually continue to meet with you to assess your progress.
NFCC, a nonprofit financial counseling organization, has a credit counselor locator to help you find assistance in your area. Call 1 (800) 388-2227, or go to NFCC.org to find the online locator.
Some financial advisers will also help you work on a debt elimination plan, according to Stratton.
"Not every financial adviser wants to do this. A lot just want to manage your assets," Stratton says. "But more and more financial planners are willing to help clients with debt repayment."