Financial Literacy 2007 - Home equity
home equity
4 easy steps to less debt

Aggressively tackle debts

With more money coming in every month, there are two ways she can attack the debt.

Because Cathy owes more than the home is worth, she could make reducing the balance on the home equity loan the first priority for any additional cash she raises. She'll need to create equity in her home to have any hope of refinancing. She'll need to reduce the balance by $10,000 to $15,000 in order to refinance.

Conversely, if she foresees next year's payment increase of more than $100 per month on the mortgage as manageable, then the strategy changes. After all, that mortgage payment will be fixed for the ensuing five years following the adjustment.

In this case, the focus should be to devote every resource to paying off the $13,000 personal loan at 21 percent. Scraping together an additional $400 per month through pay raises, overtime and additional income would enable her to pay that loan off in less than two years - just in time to become eligible for the employer 401(k) match in January 2009. Eliminating that $375 per month payment will give her a bit of breathing room to accelerate the credit card repayment, contribute toward retirement, and build a savings cushion - but only if she can hold the line on expenses!

Cathy has a long road ahead and progress will be best marked in stages. The first step is to eliminate the $500 monthly deficit in her budget and get back to break even by aggressively slashing expenses. The next stage comes when she can pull together additional income to make headway against her debt. Only then, after a period of demonstrated cost-cutting and sacrifice, will she be in a position to start building a financial future through regular savings and the reinstatement of her retirement contributions. The first order of business, though, is to aggressively cut expenses in a bid to get out of the hole that gets $500 deeper every month. If Cathy thinks this is not attainable, she should consider debt counseling as an alternative.

The plan in 4 steps
1) Stop charging up credit cards.
  • Reduce paycheck withholding.
  • Work some overtime or take a second job.
  • Sell the time share.
  • Stop 401(k) contributions (for now).
  • Suspend IRA contributions.
  • Suspend the 529 college contributions.
Tips: 5 frugal tips for 40-somethings
2) Create a written spending plan and follow it.
  • Get on a budget and follow it.
  • Slash miscellaneous spending by half.
  • Give daughter a modest allowance.
  • No more satellite dish.
  • Suspend charitable donations.
Tip: Create a budget work sheet
3) Raise cash to zap credit card balances.
  • Reduce home equity balance.
  • Pay down high-interest loan balance.
  • Stop using credit cards.
  • Put all extra income and cash against card balances.
  • Free up equity in the home so a refinance is possible.
Tool: Debt paydown calculator
4) Build an emergency savings account.
  • Investigate the new programs from Fannie Mae and Freddie Mac for loan refinancing.
Tip: Crunch the numbers to see if a refi is wise

This report was prepared by Bankrate Senior Financial Analyst, Greg McBride, CFA.
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