108. What are the real options to reduce debts?
Want to reduce debts – really?
Think about it this way: when you’re playing a game (be it chess or any competitive sport), your first move could be very telling of how you are going to play.
So before you make that move, decide.
Decide which strategy to reduce debts works best for you.
Here are just a few of your options:
1.) Pay the highest interest rate balance first.
This strategy is definitely the most popular, but it may or may not be the best for you.
Just like alot of things, it has its pros and cons. It’ll wipe out your costliest accounts first, but it may take a long time (the longer the time something takes, the more likely it is to lose its original purpose).
So there is a risk because it takes a while, but if you keep focused and remain attentive to this strategy, it’ll work. When you reduce debts this way, you’ll end up saving by paying less total interest.
The other downside is the fact that it wil not help your credit score in the short term because of the time it will take.
However, your short term credit score may not be as important to you as putting a dent on your debt.
Also, this method allows you to “snowball” your debt. When you snowball you:
- A.) Identify and separate “good” debt from “bad” debt. Good debt is debt that is tax deductible (home loans, student loans, etc.).
With good debt, you are really not paying the interest rate you think you’re paying. Your real rate is your “after-tax” rate.
You can have fun calculating your after-tax rate. You will need to know what federal tax bracket you’re in.
For example, if you’re paying 6.5% on a mortgage and you’re in the 25% tax bracket, you’s subtract .25 from 1 to get .75. Then you’d mutiply that times .065 to get .04875 or 4.875% as your after-tax rate.
Bad debt is easy – it’s not tax deductible.
- B.) Sort from highest to lowest rate.
- C.) Pay off highest rate debt first.
- D.) While you do that, only pay the minimum on the other debts.
- E.) After you’re done paying off the highest rate account, apply the same payment to the next highest rate debt.
- F.) Repeat C-E until all debts are paid.
2.) Pay the smallest balance first.
This stategy to reduce debts gives you a quick win to lift your spirits and keep you motivated. Just that right there can be enough to choose this method.
However, if other debts have much higher rates, it’ll cost you in the long run because you’ll pay more in total interest.
3.) Pay the balance that’s closest to its limit.
If one of the credit cards has reached its credit limit, it could trigger an interest rate increase – not only for the maxed out account, but also for any other accounts that have the “universal default” penalty. (That’s why when you apply for a credit card, you need to watch it!).
Whichever option you choose to reduce debts, the key is to stick with it.
The idea for all of these is to focus on paying as much as possible to one account at a time while paying as little as possible (minimum +$10) to all the other accounts.
Why add $10 to the minimum you ask?
Because some lenders will penalize you for paying only the minimum. That’s right, another small but important rule you should know about when playing the game.