Sunday, December 17

Get Out of Debt

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Get out of debt

Before you begin to figure out how to reduce your debt, you must create an assessment of your income. Include only the income you are certain to get; do not consider possible pending freelance assignments or any other potential source of income.  This net income figure will be used to meet all expenses, including debt payments. Then you must calculate expenses. Once again, you must be honest. First, list all of your monthly expenditures as accurately as you can. House payments, insurance, food, gasoline, entertainment, clothes, insurance, taxes, utilities; all of these must be included but do not include debt payments. Those will come later. House payments are not included in the list of debts because they are not optional. You will make a house payment or a rent payment no matter where you live so those are included as regular monthly expenses.  You must be brutally honest in creating a record of what you actually spend. If you get a Starbucks coffee five days a week, include the $4.50 you spend. If you plan on just one but you actually buy another at your morning break, the second one must be listed. You are creating a record of your real expenditures, not just an estimate of what you think you ought to spend or what you think you actually spend.  

Now you must compare your income with your expenditures. The difference (assuming there is at least something left over) is what you can pay towards reducing debt. If the total does not reach the sum of the minimum payments you must make, then you have no option but to reduce spending. Do you really need Starbuck’s coffee at $4 a cup or will the 79 cent special from the convenience store do just as well?  If you cannot find a way to raise your income, then you must cut your expenditures. You must be brutally honest about what you actually spend. If your response to how many lottery scratch tickets you buy in a week is “a couple”, look again. That $4-a-week expenditure might turn out to be $12. That is $8 per week you can cut. More than $30 a month added to debt repayment. It is absolutely essential that you honestly assess where you spend money and how much.

Once you have a firm understanding of what you spend, simply add up the minimum payment for every debt. Add spending amount to the minimum payments and then subtract the total from net income. The remainder (if there is one) constitutes discretionary funds. If your spending total plus the required minimum payments exceeds your income, you have three options: increase income, reduce spending, or file bankruptcy. If you believe bankruptcy is inevitable, go ahead and do it. Do not throw away hundreds or thousands of dollars trying to pay enough to delay the inevitable. You will need those funds later. Do not wait for creditors to file against you in court. If an injunction ordering you to pay has been obtained, it might be voided by bankruptcy but it might not. Once your bankruptcy petition is accepted by the court, no valid injunctions can be filed. So if it is inevitable, you must make it happen rather than just let it happen.

Assuming you have enough after expenses to make the required minimum payments, the issue then becomes how to reduce debt. The most effective way to do that is to focus on a single debt and just pay a little over the minimum (never pay just the minimum) on the rest. Do not (DO NOT!) add any expenditure whatsoever to that account. Pay it off as soon as you are able and then either close the account or ignore it. Pick the next one and pay it off. There are several methods that have been proposed to select which account should be worked on first. Some say the one with the largest minimum payment; others say the one with the highest interest rate. I think those plans will work but it will be a long time before you have visible results. A better way is to pay off the debt with the smallest balance. You will have visible results very quickly, which will encourage you to stay with the plan.

Whatever decision you ultimately make about how to handle your debt, it must be preceded by an honest and complete assessment of income and expenditures. If bankruptcy is the only viable option, do not wait. File the petition and stop paying existing debt. You may find you will be able to make your house payments after all and bankruptcy usually does not include mortgages.

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