Three Strategies to Reduce Debt
I’ve just been ignoring that number…
…and it’s gotten really big.
Debt Reduction Strategies
Debt. Such an awkward topic. Society make’s it feel almost shameful. But if you carry some debt, you are not alone!
If you’re hoping to buy a house someday, it’s important to make a plan to start paying that down. Not only will lower debt levels help your credit score, but one of the major things a lender will look at is your debt to income ratio. Let’s begin.
The first place you should spend excess funds outside of necessary expenses is to PAY DOWN YOUR DEBT.
“But I really love going out to eat?”
I know. We do too. Let’s take this step by step.
Step 1: Write it Down
The first step in creating a good plan to pay off your debt is to write down all the debt you have. Include interest rates, balances and minimum monthly payments to give you an idea of all of your liabilities and minimum payments. You can find all of this information either online, your statement or by calling your financial institution. This visual representation will be an excellent (and likely eye opening) start for you. Open Excel for the fist time on your personal computer and make a spreadsheet. Organizational freaks, are you with me?!
Step 2: Rank and Yank
If you have more than one debt source, step 2 is to decide which balances you will pay down first. There are two options when deciding which balance to pay down first.
The first option is to target the debt with the highest interest rate. Using this train of thought: if you owe money on 2 lines of credit, one with a 15% interest rate and 1 with a 5% interest rate, you would pay down the balance with the higher interest rate (15%) first.
The second train of thought is to pay down the lowest balance, irrespective of the interest rate. Using this method: if the 15% line of credit has a balance of $20,000 and the 5% interest rate has a balance of $3,000, you would start by paying down the lower balance or $3,000 despite it having the lower interest rate.
Lets get real: From a strict numbers perspective paying the highest interest rate first makes the most sense. In this strategy, you are paying down the debt that is costing you the most which will save you over the long term. However, there is something satisfying about achieving a small success like paying off a credit card. So we are actually advocates of paying off smaller balances over higher interest rates. If you have no problem creating and sticking to a payment plan then pick option 1, the higher interest rate. Otherwise, take the small victory of getting one of your debts off your shoulders and build on your momentum by paying off the lowest balance first.
Step 3: Be. Aggressive. Be. Be. Aggressive.
Finally, step 3 is to put measurable and aggressive time frames in place to pay off your debt. Just like a mortgage has a set payoff date (15 years or 30 years for example), so too should your other debt. This is where you need to take a look at your cash flow (i.e. how much money you have coming in) (i.e. dumb it down even more, your salary!!) and decide exactly how much of your excess positive cash flow you are going to put toward each debt. By doing this you are more likely to stick to a pay-off plan.
Employing these strategies to reduce debt prior to buying your home will make your home buying process much more enjoyable. And if you’re furling your eyebrows about paying down debt to take on new debt, a mortgage, stop! Mortgages fall into the category of “good debt.” The type that can actually help you make money. Wait, what?