Updated: 10/11/2011 4:20 PM ET|
A debt payoff plan that works
Prioritize your debts
Now that you've sorted your debts, start with your toxic pile and identify the highest-priority debt, which is typically going to be the debt with the highest interest rate.
There are some exceptions. You may want to:
- Target maxed-out credit cards. If you have a card that's at or near its limit, consider paying that down first, even if it has a favorable interest rate. Maxing out your cards can trigger higher rates and torpedo your credit scores. How far you should pay it down isn't an exact science, but in general you'll want to get your balances below 75% of your limits.
- Pay off a small bill if you need a quick win. If you're really overwhelmed by your debts, knocking out at least one bill can give you the motivation to keep going.
- Consider accelerating a retirement-plan loan if your job is at risk. Retirement loans typically have low, fixed rates, which means they needn't be a priority -- unless your job is shaky. Most plans require you to pay back 401k and other retirement plans quickly after you leave your employer, or the balance you owe becomes a withdrawal and triggers a fat tax bill.
Remember, you'll pay the minimums on all your other bills so you can throw as much as possible at your priority debt. Once that debt is paid off, you take the same payment and apply it to your next-highest-priority debt.
Craft your plan
You can use this debt reduction calculator to choose your approach (lowest balance or highest interest rate) for your toxic debts. It will allow you to try out different scenarios so you can see how a few more dollars, or a different repayment order, would affect how soon you'd be of debt.
After your toxic debt is dispatched, you may want to switch to other priorities, such as building up your emergency fund and saving more for retirement. When those bases are covered, you can start working on your neutral debt and then your good debt.
Of course, you'll have to find the money to pay down these debts.
Before you start throwing any extra money at your bills, try to be realistic about whether your plan could work.
If your toxic debt totals half or more of your current income, or it would take you more than five years to pay it off, you might be better off considering other methods, including credit counseling, debt settlement or bankruptcy.
Implement your plan
If your plan is realistic, put it into place. An online bill payment system can allow you to set up your payments and quickly transfer extra funds where you want them to go. Remember:
- Don't add to the pile. Stop charging. If you absolutely need to use plastic (for business travel, for example), use a card that you can pay off in full when the bill comes.
- Find a community for support. Debt repayment takes time, and the support of others in the same situation can keep you going.
- Review your minimums monthly. Credit card minimums can change if your interest rate changes. Even if your rate stays the same, your minimum may gradually drop over time if you don't add to your debt. Consider automatic debits, which allow the credit card companies to take the correct minimum payment monthly from your checking account.
- Don't forget to snowflake. Continue to look for little expenses you can trim, and set up transfers so the saved money is applied to your debt.
- Calve your way to financial freedom. Apply at least half of any windfall (tax rebate, refund check, inheritance or bonus) to your highest-priority debts. These big chunks can cut the time you stay in debt.
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
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