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Thursday, Jan. 12, 2012 10:33 am

How to manage personal debt

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As if anyone needs their memory jogged, debt is a substantial problem for men and women living in fully developed countries. Estimates vary, but numerous surveys have indicated the average American household has more than $10,000 in credit card debt, a figure that doesn’t include debt such as mortgages, car loans or student loans.

The most financially savvy debtor may be in a precarious position, one that, should an unforeseen layoff or medical emergency occur, could turn disastrous in a relatively short period of time. As a result, an individual’s ability to manage personal debt is of paramount importance, and the following tips can help men and women walking a financial tightrope address their debt in a way that might help them get back on their financial feet.

Eliminate bad debt. Not all debt is bad, but credit card debt is rarely good. Card holders with substantial credit card debt should contact their companies as soon as possible to see if the company is willing to work with them on a repayment plan. This is more prudent than declaring bankruptcy, which will negatively impact an individual’s credit score for years to come. Companies are often willing to work with card holders about repayment plans that make it easier to pay down debt. But once an agreement is made, card holders must make meeting the terms of that agreement their top priority.

Stop accruing bad debt. Using a card wisely is the key to avoiding unnecessary debt. Do not use credit cards for everyday purchases like groceries or movie tickets. This type of credit card usage is habit forming, and it’s very easy for card holders to quickly amass a large balance on their accounts for items they just as easily could have paid for with cash. Keep in mind interest will be charged on all balances not paid in full each month, so don’t make that cup of coffee or that pair of movie tickets cost even more by adding interest to the overall cost.

Pay down high-interest debts first. Always work to pay down high-interest debt first while paying a little more than the minimum on low-interest debt. If a car loan came with an especially high interest rate (hint: borrowers whose down payment on a car loan was small or nonexistent are likely saddled with a high-interest loan), work to pay down that balance as much as possible. Something as simple as paying an extra $25 per month on a $200 per month car payment can reduce the length of time it takes to pay off that loan considerably. Once a high-interest debt is paid off, move on to the debt with the next highest interest rate.

Stop paying the bare minimum. Paying just the minimum will barely cover the interest. That means the principal will hardly disappear, and the debt will be a seemingly impossible obstacle to overcome. Pay more than the bare minimum each month, even if it means making sacrifices elsewhere.

Avoid borrowing from Peter to pay Paul. Transferring balances from a high-interest card to a low-interest card is one thing, but borrowing against property or a retirement savings account is playing with fire. With regards to borrowing against a 401(k), the penalty to do so before retirement is substantial. Also, such a withdrawal will accrue extra income tax. In addition, the value of those retirement savings will suffer considerably, because the interest earned will be on that much less money until the full amount is paid back to the account. 

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