What’s the first thing you do when driving to a place you’ve never been? You look at a map. And where’s the first place you look? Where you are. Only after finding your current location do you then seek the place you’re trying to reach. By comparing the two, you can figure out how to get there.
First Steps for Paying Off Your Debts
And that’s the first thing you’ve got to do with your debts: You must become an expert on where you are. Do you know exactly how much money you owe and to whom you owe it? Can you tell me the cost of that debt — the interest rate and minimum payment?
Too often, people in debt have no idea how much they owe. If you don’t know the details, you can’t fix the problem. Telling your mechanic that the car doesn’t work is not much help. He’s got to know exactly where the problem is — before he starts repairs. Similarly, if you don’t have a firm grasp of exactly what you owe, to whom you owe it, and what the payment terms are, forget about trying to eliminate your debts. So let’s start there.
Take a sheet of paper and make four columns. In the first column, list the name of each creditor (who it is you owe). In the second column, list the amount you owe to that creditor. Third, state the interest rate each is charging you, and fourth, state the minimum payment you must make each month.
Now that you have your list, I’ll bet you wrote them down as you thought of them, in random order. So let’s do it again, but this time start with the creditor which charges you the highest interest rate. Place the 21% credit card above the 18% credit card, which appears above the 14% card and so on — even if you owe more to the 14% card than to the 21% card.
I emphasize the rate instead of the balance because we have to stop the bleeding before we can cure the patient. You’re not going to get rid of your debt overnight, and until you do, additional interest charges are accruing. Therefore, you must reduce the speed with which interest charges are accumulating, and that means we have to focus on the debt that’s charging you the highest interest.
Now that you have listed all your debts in the proper order, look at column four: the minimum monthly payment. Each month, make certain you pay the minimum payment to each creditor. Never skip a payment and always send at least the minimum. If you don’t, the creditor will make a note in your credit file, and this will haunt you when you try to buy a house or a car. Make sure you stay current. I cannot overemphasize the importance of this.
After you pay the minimum to each creditor, devote all your remaining money exclusively to the creditor that charges you the highest rate. Do not spread this money evenly among all the debts. Instead, send whatever you have left entirely to the most expensive creditor. After you finish paying off that creditor, go down your list to the next — highest creditor, again devoting all resources (beyond the minimum payments) to that creditor until that debt is gone too, and keep repeating this process until they’re all gone.
Empty Your Bank Account
To accelerate this process, withdraw any money you have in the bank and send it off to the creditor at the top of your list.
If this advice shocks you, please understand that it makes absolutely no sense to have money in the bank earning tiny amounts while you have debts that cost 18% or 21%. While you’re at it, liquidate any other assets you have, such as savings bonds, stocks, mutual funds, and even baseball cards.
Liquidate your assets, with one exception: Do not liquidate your IRA or company retirement accounts. The tax penalties would be so high, and you would be jeopardizing your future retirement to such an extent, that it’s not worth it.
“But if I close my bank account, I won’t have any money,” you might be complaining. Well, I’ve got news for you: You don’t have any money now! You just don’t realize it. And if you’re worried about needing cash in the event of an emergency, let me ask you: What do you think a credit card is for?
I love credit cards. What I don’t like is credit card debt. Credit cards are wonderful cash management tools, and I encourage you to obtain one and keep it with you. If the car breaks down during a road trip, you can pay for repairs and overnight lodging. If Aunt Ida needs you to care for her, you can buy a plane ticket to see her right away.
So I have no problem with credit cards. What I have a problem with are people who don’t pay them off every month, and with people who own assets that produce lower returns than the cost of the debt, when they should be selling the assets to eliminate the debt.
Get Out of Debt by Getting into Debt
Next, go borrow some more money.
And get as much as you can — provided that (a) the amount of money you are now borrowing is not more than the total amount of debts you already have and (b) the interest rate you’ll have to pay on this new debt is less than the rate you’re currently paying.
See how this trick works? Say you owe $5,000 to an 18% Visa card. Maybe you can get a new Visa card from another bank that charges only 14%. Take $5,000 from the new card to pay off the balance on the old card — and in essence, you’ll cut your interest rate to 14% from 18%. Do this as often as you can to reduce your interest charges while you’re working to eliminate the debts themselves.
Keep in mind that this is just a temporary solution. The real goal is to eliminate the debts, not merely reduce their cost. And be sure you understand the terms of your new card: Many card issuers offer introductory rates to get you to switch, but these “teaser rates” often last only a few months, after which time the rate rises dramatically — perhaps to a rate even higher than the rate you’re currently paying. In other cases, the low rate applies only to new purchases, not to existing balances that you transfer from another card. Execute this strategy carefully, or you’ll defeat the purpose.