In America today, carrying some debt is unavoidable, and even
desirable, for most households. But between mortgages, car
payments, and credit cards, many Americans find themselves over
their heads -- unable to dig out from under a growing debt burden
that consumes an ever growing portion of their resources.
The average U.S. household owes $6,849 in credit card
debt.1 Credit card companies have made running up that
balance deceptively convenient. What's lost when you're on that
spending spree is the realization that paying off your debt can be
costly, in terms of both cash on hand and your overall financial
Assessing Your Debt
How much debt is too much? The figure varies from person to
person, but in general, if more than 20% of your take-home pay goes
to finance nonhousing debt or if your rent or mortgage payments
exceed 30% of your monthly take-home pay, you may be
Other signs of overextension include not knowing how much you
owe, constantly paying the minimum balance due on credit cards (or
worse, being unable to make the minimum payments), and borrowing
from one lender to pay another.
If you find that you're overextended, don't panic. There are a
number of steps you can follow to eliminate that debt and get
yourself back on track. Working your way out of debt will, of
course, require you to adjust your spending habits and perhaps be
more judicious in your spending.
Debt Assessment at a Glance
Here's how you can build a clear picture of your debt
- List all of your credit cards and how much you pay to them each
- List all of your fixed loans (such as car loans and student
- List all the annual expenses you pay off with regular monthly
payments (such as insurance);
- List your monthly mortgage or rent payment.
Once you are done, add them all up. That's your total monthly
Begin With a Budget
The first step in eliminating debt is to figure out where your
money goes. This will enable you to see where your debt is coming
from and, perhaps, help you to free up some cash to put toward
Track your expenses for one month by writing down what you
spend. You might consider keeping your ATM withdrawal slip and
writing each expense on it until the money is gone. Hang on to
receipts from credit card transactions and add them to the
At the end of the month, total up your expenses and break them
down into two categories: Essential, including fixed expenses such
as mortgage/rent, food, and utilities, and nonessential, including
entertainment and meals out. Analyze your expenses to see where
your spending can be reduced. Perhaps you can cut back on food
expenses by bringing lunch to work instead of eating out each day.
You might be able to reduce transportation costs by taking public
transportation instead of parking your car at a pricey downtown
garage. Even utility costs can be reduced by turning lights off,
making fewer long-distance calls, or turning the thermostat down a
few degrees in winter.
The goal is to reduce current spending so that you won't need to
add to your debt and to free up as much cash as possible to cut
down existing debt.
Three Steps to Reduce Debt
Once you've got your budget settled, you can begin to attack
your existing debt with the following steps.
Pay off high-rate debt first. The higher your
interest rate, the more you wind up paying. Begin with your
highest-rate credit cards and eliminate the balance as aggressively
as possible. For example, assume you have two separate $2,000
balances, one charging 20% interest, the other 8%, on which you can
pay a total of 6% per month. If you were to pay 4% per month on the
higher-rate card and 2% on the lower-rate card (which is typically
the minimum monthly payment), you would save $961 in interest and
18 months of payments over allocating 3% to each balance.
Transfer high-rate debt to lower-rate cards.
Consolidating credit card debts to a single, lower-rate card saves
more than postage and paperwork. It also saves in interest costs
over the life of the loan. Comparison shop for the best rates, and
beware of "teaser" rates that start low, say, at 6%, then jump to
much higher rates after the introductory period ends. You can find
lists of low-rate cards online from sites such as CardTrak and
If you can only find a card with a low introductory rate,
maximize the value of that low-interest period. By paying off your
balance aggressively, you will reduce the balance more quickly than
you will when the rate goes up.
You can also contact your current credit card companies to
inquire about consolidation and lower rates. Competition in the
industry is fierce, and many companies are willing to lower their
rates to keep their customers. Even a percentage point or two can
make a difference with a sizable balance.
Borrow only for the long term. The best use of
debt is to finance things that will gain in value, such as a home,
an education, or big-ticket necessities, like a washing machine or
a computer, that will still be around when the debt is paid off.
Avoid using your credit card for concert tickets, vacation
expenses, or meals out. By the time the balance is gone, you'll
have paid far more than the cost of these items and have nothing
but memories to show for it.
By analyzing your spending, controlling expenses, and
establishing a plan, you can reduce -- and perhaps eliminate --
your debt, leaving you with more money to save today and a better
outlook for your financial future.