There are a variety of ways for people who are struggling with out-of-control debt to begin to get some control. The most drastic measures, like bankruptcy, should only be considered after all other options have been tried. If your situation is still manageable and you’re willing to work toward fiscal responsibility, there are some things you can do to avoid financial catastrophe. To begin addressing the issue, the following four steps will help you kick start your effort and begin to see light at the end of the tunnel.
Assess Your Situation
Honesty in evaluating your debt is the very first step to resolving any financial crisis. Many people delude themselves into believing that their situation isn’t as bad as all that. But the question that needs to be answered is how much debt is too much. While there isn’t an answer that fits every situation, most experts suggest that no more than 20 percent of your monthly income be necessary to cover credit cards and other unsecured debt; rent should not exceed 30 percent. If you exceed these limits you are generally considered to be overextended. One other important sign of trouble is not having the resources to pay more than the minimum on credit card debt.
An easy calculation used by banks and lenders the ratio of debt-to-income. The lower your ratio the better; in fact, it’s the number that is used to determine mortgage and loan approval. Add up all monthly income, including wages, social security, pensions and all monthly debt payments, such as mortgage, credit cards, auto and personal loans. Living expenses are not included in the calculation. Here’s how to do the math:
Take your total monthly income and divide it by your monthly debt payments. For example, if you make $3,000 a month and you have a monthly debt payment totaling $1,000, your debt to income ratio would be 33%.
Prepare a Detailed Budget
Many people make the mistake of thinking they can spend less without drawing up a plan. But most of us don’t recognize the traps that put us over a reasonable spending limit, for example, a coffee a work day from a local barista and you’ll spend more than $150 a month. A detailed budget also helps keep us on task and less likely to stray from our commitment. Begin by making three lists: monthly income, necessary expenses and nonessential but desired expenses. To get a more accurate picture, write everything down for an entire month. The more details you include the easier it will be to spot areas to make improvements.
It’s plain old, common sense that cutting expenses is an important part of getting debt under control, but it’s also easier said than done. One thing is for sure for most people, it’s easier to spend less than to earn more, at least in the short term. While fixed expenses such as mortgage and car payments will be hard to cut, limiting nonessential spending will reap the biggest rewards in lowering debt.
Consider bringing your lunch to work rather than splurging on fast food every day. Jump on the bus or train, car pool with coworkers to cut transportation costs. Lower the temperature when you’re away from home and other cost cutting measures may be mere pennies by themselves, but when added together you can make a decent dent and open up opportunities to use your money more wisely.
By putting these three steps in place you will begin to see more clearly where you need to cut and what debt obligations should be at the top of your repayment list, those that are charging the highest interest rates. The sooner you reduce those balances, the less interest you’ll pay and the faster you’ll reduce your debt.