How to Manage Debt

The first step in managing any crisis, and excessive debt is no exception, is to focus on facts. Here, that means finding out how much you actually owe and what the monthly payments and interest costs.

It’s surprising, though maybe it shouldn’t be how many people that are troubled by debt problems don’t actually recognize how much monthly interest they’re paying. Part of the trouble may be that they really don’t want to know. Considering how much it is for some, one can hardly blame them.

But the first step back to financial health is a good analysis of your current situation. If you’re paying $200 interest charges every month on a monthly net income, say, of $4,000, then you are paying 5% PER MONTH of your income for really nothing. It’s not completely nothing, since you are enjoying the things you bought early on. You would have had to save to get them outright. But is that worth 5% of your earnings?

When that $200 a month (and for many, it’s much more) becomes the total you can pay every month, you have reached a point where you will never get to pay all the debts. If all the money is going to interest nothing is going to principal. That may be a severe case, but consider how much of the monthly payment goes for interest against repayment of principal.

Suppose it is 90% interest, 10% principal. That’s around the case for the average home loan for the first couple of years. You can use an online calculator to check how long that will take in your situation.

Suppose, for instance, your debt is $10,000 at 7%. You can pay only $116 per month, but it would take you 10 years to pay it off. The interest would cost you $3,933 - approximately 40% of the principal amount.

Now that you had a glimpse your situation, you need to take two more steps. Prepare a budget that will allow you to make payments as huge as you can handle to get the bills paid off. You could use the ’snowball method’ and pay off the least one first. Then apply what you were paying to the smallest to the next smallest (now the smallest), until you’ve got through the end.

On the other hand you could pay down the biggest bill. That would save you the most in interest charges, but it’s difficult for lots of people to stick to it, when they see such slow development.

Now, for the most difficult - and most important - step (which should be accomplished at the same time with the first): stop borrowing. You should not allow yourself to acquire any further debt until you have paid off the first down to a sensible level. That level is zero for credit card junkies. For some, it may be in the 5% range. For others with good drive and are willing to take up the overhead, 20% is the maximum.

Confronting reality and making a commitment to lasting change are the two toughest things to do for anyone who has gotten into financially turbulent waters. But they are the bare minimum necessary, if you want to pull through your financial health and freedom.