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How to get out of debt
How I did it: When my husband and I got married 12 years ago, our finances were a mess. We both had been struggling to make ends meet and were behind on paying bills. Between us, we had student loans, legal bills, store credit cards up to the max, medical bills, and a lot of smaller bills he inherited in his divorce, some of them with collection agencies. We also got a car loan a couple of years later. It took us several years, but it was worth the hard work!
- Make a pact with yourself & significant other not to accrue more debt.
- Make paying off your debts a higher priority than luxury spending.
- Commit to paying all of your bills on time. This will improve your credit so you will qualify for money-saving opportunities for re-financing.
- Get copies of your credit reports from all three credit report agencies so you know you aren't missing anything.
- Make a list of all of your debts, the amounts, the minimum monthly payments, and the interest rate on them.
- See if you can reduce the minimum monthly due on as many debts as you can. Call the companies at the number on the credit report and negotiate for lower payments or lower interest rates. See if you can re-finance loans at a lower interest rate. Consolidate multiple student loans at a lower interest rate. See if you qualify for a low interest balance transfer offer on a credit card to combine several debts into one. All of these things can lower the minimum payment due. While you are talking to the companies, negotiate the payment date too to make it easier to get the bills paid on time. Allow 5 business days for the payment to arrive in the mail and be credited to your account. When you are done, update your list to reflect your changes.
- Every payday (not just once a month), take any money you have left over after paying your bills and setting aside enough for necessities until the next payday and put it towards the debt with the smallest amount due. Keep paying the minimum due on all of your other bills.
- When you pay off the smallest bill, take the minimum amount due on that bill and add it to what you usually pay on the debt with the highest interest.
- Continue in this manner, paying off the smaller debts and increasing the payment to the highest interest rate debt each time you do. When you pay off the highest interest rate debt, add the last payment amount to the debt that has the next highest interest rate.
- Once a year, as your credit improves, revisit #6.
Lessons & tips:
- If you want to cancel a credit card that you've paid off, make sure you do it in writing and ask that the company note on your credit report that the card was canceled due to customer request.
- Study up on how different actions affect your credit score. It might make sense to you to lower your available credit on a card or cancel all of your cards, but these may impact your credit score negatively, as will transferring a balance to a card above 2/3 of it's max. These are not long-term impacts and won't affect your score far into the future. Making a late payment or defaulting on a loan will affect it for 7 years in most cases.
- You can't transfer balances to cards owned by the same company as the card you are transferring on. Most balance transfer offers come with a balance transfer fee. Make sure you understand how much it will cost you to transfer the balance.
- When comparing balance transfer offers, use an online calculator to determine the best deal. A longer term low-interest offer may be better than a shorter term zero interest one.
- Only transfer balances to cards that do not have a current high-interest balance. The lowest interest rate debt on a card is always what your payments will be applied to. For the same reason, never charge anything on a card that has a transferred balance on it. Put it in a safe place so you don't accidentally use it. If you have any recurring charges to a card, don't use it for a balance transfer. It's best to keep those charges on one card so you can use the others for balance transfers if need be.
- Pay careful attention to the expiration date of a balance transfer offer. If you can't pay if off by that date, plan to transfer that balance to another card about a month beforehand. Don't get rid of the old card, you may want to transfer a balance back to it in the future.
- Never be even one day late in making a payment to a card with a balance transfer on it. If you are, they might instantly raise your interest rate. If this happens, call them and see if they can give you a break.
- Scrutinize your bills and statements as they come in. Companies sometimes misapply or misplace payments, then mark them as being late or not paid. If this happens, call the company and be ready to offer proof of your payment. You want to keep a late payment from showing up on your credit report. Even if you feel you have straightened it out with the company, wait two or three months and get a copy of your credit report to check. If the company reports it as late on your credit report, then goes out of business, you will have a really hard time clearing it up if you can at all.
- Using a bill-paying service with your bank gets your payment applied quicker and also makes solid proof of payments and payment dates.
- Free credit reports (the official site): https://www.annualcreditreport.com/cra/index.jsp
- Rates for mortgages, auto loans & balance transfer offers: http://www.bankrate.com/compare-rates.aspx
- Mortgage Rate Calculator: http://www.bankrate.com/calculators/mortgages/refinance-calculator.aspx
- Balance Transfer Calculator: http://www.bankrate.com/calculators/credit-cards/balance-transfer-calculator.aspx
- Debt management advice at bankrate.com: http://www.bankrate.com/debt-management.aspx
- Credit & Debt section of the Motley Fool: http://www.fool.com/personal-finance/credit/index.aspx?source=ifltnvsnv0000001
- Credit Cards & Consumer Debt discussion board at the Motley Fool: http://boards.fool.com/Messages.asp?bid=100145
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