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Simple Steps to Debt Reduction

In this topic, we cover:

  • How to analyze your debt.
  • How to improve your cash flow.
  • Why setbacks shouldn't derail your efforts.

Pencil eraser taking the

Many individuals with debt problems have found that a simple, eight-step plan is an effective way to conquer their problem. If you're considering trying this strategy, it's helpful to keep in mind that it's not a one-time process - it's an approach to spending that you'll continue to refine as needed. In other words, even if you eliminate all debt once, you'll want to avoid getting into the same situation again!

Step One: Stop Creating Debt

Seems simple, right? Many of us use debt to maintain a certain lifestyle, but the problem is that increasing debts are not sustainable for anyone. So the first step is to avoid new debt, no matter how good of a deal you may find on special financing offers.

Step Two: Analyze Your Debt

Calculate how much you owe, both as a total number and as a debt-to-income ratio. Reducing these two numbers will give you concrete evidence of how your debt reduction plan is progressing. If you need help in calculating your debt-to-income ratio, please see the topic: Your Debt-to-Income Ratio.

Step Three: Improve Cash Flow

Cash flow is simply your monthly income minus your expenses:/p>

$6,000 income - $5,000 expenses = $1,000 cash flow

In this case, the cash flow is $1,000, which is considered a positive cash flow. But if expenses had been higher than income, the cash flow would have been negative - an unsustainable situation if it happens every month since overall debt continually increases. A positive cash flow is key for reducing debt. If yours is negative or too close for comfort, you'll need to earn more income or find a way to reduce your expenses so that they're consistently lower than your income. Otherwise, you'll never have "extra" money for paying down debt.

Some expenses, like a mortgage or rent payment, are fixed - meaning there's not much you can do to change them. But much of our spending is variable - meaning there could be less expensive options or you could avoid the spending all together. Creating a monthly budget helps you set spending priorities that work towards your financial goals. Our Monthly Budget and Budget Tracking tools are both helpful for establishing a budget and monitoring your progress over time. Even tracking spending closely for a month or two can yield unexpected opportunities for saving.

Step Four: Refinance and/or Consolidate Debt

In some cases, it may possible to reduce interest rates or lower your monthly payments by seeking more favorable financing terms or by combining small debts into one larger one. This strategy may help to free up money that can be applied to reducing debt. Especially if you're carrying high interest credit card debt, a personal loan from a bank or credit union could make a big difference. But this strategy isn't without risk since, in many cases, consolidating a loan increases your available credit, potentially making it easier to get into even more debt.

Step Five: Use Credit Wisely

One of the most important ways to minimize interest and fees, particularly on credit card debt, is to use credit wisely. In other words, make all payments on time - even if it's just the minimum. In the event you can't make a payment of any kind, contact your lender to see if arrangements can be made that will not affect your interest rate or credit history.

Step Six: Set Goals

Establishing financial goals makes it easier to measure your progress. Your goals could be to pay off a credit card in a certain amount of time or to get your debt -to-income ratio down to a certain number. Either way, goals can help. The Financial Goals tool offered by this website will help you set short and long-term goals. You can even create checklists to better monitor your progress.

Step Seven: Implement and Monitor the Plan

Now that you have a plan to get out of debt, it's time to put it into action. In the beginning, you may be highly motivated to make the changes in your spending that will help you pay off your debt. But life doesn't often go according to plan, so it's important to not allow setbacks to frustrate you too much. Each month, week and day is a new opportunity to pursue your financial goal of reducing your debt.