Wednesday, July 19, 2006

The Debt/Income Equation - Six Ideas for Getting Out of Debt

There is no avoiding it, the debt-income equation is the key to everyone's financial future. It is a key factor for everyone's fico score. If your monthly debt exceeds your monthly income, you are in trouble. It is that simple. And many people are in the same boat. The average credit card debt in the United States However, if you are in debt, how can you hope to repay it? Often times, interest rates for credit cards are the culprit. If you have a good credit score (check it at freecreditreport.com), you may be able to do a balance transfer or negotiate with your current lender to reduce your rate. But what do you do when there is no way to get the rate reduced?

Here are some options:

1. If you have an emergency fund, consider using that savings (either some or all) to pay off your credit card debt. It is likely that in this case you can mitigate your risk by paying it off in chunks over time to save money in interest and make sure you can handle any new expenses with existing savings. These payments may, over time, give you some wiggle room to renegotiate the interest rate later and if a real emergency happens, you can suspend the paydown.

2. Consider an outside loan. If your credit is good, you might be able to apply for a loan at your local bank to pay off your card at a lower interest rate. If the bank does not turn out to be a good option, consider online lenders like prosper.com for either the full amount or a just a portion, if you don't think you can pay off the loan in three years.

3. Borrow from family. Be aware that this could have personal/family implications, but if there is a family member (whom you trust and who trusts you) that could help, you might consider borrowing the money this way, and even include some kind of interest in the payments back. However, if you have had a bad history with money in the past, you might want to avoid the damage to your relationship that this option may cause you if you feel you may not be able to repay it. Before you undertake this option, write up an agreement regarding the amount, the interest, and the payment schedule that is signed by both parties. This 'mini-contract' will likely not be used, but it can provide some sense of security about the arrangement for both of you.

Additional Tips:

1. Cut as many non-essential expenses as possible while paying down these debts to make sure your repayment period is as short as possible. See my article about gym memberships as an idea of how to start looking at your expenses objectively.

2. Do not attempt a lump-sum paydown until you have mastered your finances by not using the card or debt in question for at least 6 months. This will ensure that you have your finances in order and are able to pay your monthly bills without issue using your current monthly income.

3. Never use it again, but don't cancel the account right away. Canceling the account can hurt your credit score. It is probably best to just stop using it.

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