Over 65% of people who set a goal to get out of debt never create a plan. They never set an amount that they will pay each month, set up a mechanism to track their success, or put a target date to be out of debt. It’s no surprise that the success rate for these people is low–without a detailed action plan, there’s simply nothing there.
In this article, we outline the process for managing a debt payment plan on your own. If you decide that you’d like an online solution to walk you through this process and to help you stay on track, consider using DebtGoal.com.
Step1: Set up the basics
- Quit spending on credit cards. It’s clear that you can’t pay down your debt while continuing to spend on credit, so stop. Shred or otherwise destroy your cards. Share your techniques to quit spending and see how others fight the urge at the DebtGoal Quit Credit Card Spending Forum.
- Organize your finances for success. Having the right structure can make progress much easier.
Step 2: Define your Monthly Commitment
Making only minimum payments on your debt is expensive as these minimums will decline over time, dramatically lengthening the time it takes to pay off your debt. For this reason, the most effective debt payment plans start with a constant total monthly amount.
To determine how much you can pay each month, start with the sum of your minimum payments–this is the minimum of what you’ll have to pay and it will get you out of debt quicker than you think. From there, look at your past 60 days worth of spending to determine if you can increase this amount. Find an amount equal to or greater than the sum of your combined monthly payments that you can commit to paying each month. I always feel that it’s best to start with a conservative amount and the increase it a few months later if you determine that you can. This amount your Monthly Commitment.
Step 3: Choose a debt payment technique
Once you have chosen a Monthly Commitment, chose one of 3 strategies for allocating this total amount to each of the debt accounts:
- Constant payments on each account: with this technique, the borrower pays a constant amount to each account each month until the debt is paid off. This is the simplest mechanism to execute, but doesn’t optimize repayment by putting as much as possible to your highest-interest debt.
- “Snowball”: with this technique, the user holds the Monthly Commitment constant, makes minimum payments on all accounts but the lowest-balance account and allocates as much as possible to this lowest-balance account until it is paid off. After that account is paid off, the borrower shifts focus to the next lowest-balance account and continues to apply as much as possible to this account.
- “Debt stacking”: this is the most efficient technique and is the one advocated by DebtGoal.com, as it can result in savings on interest costs of nearly 10% relative to the other techniques. With this approach you hold your Monthly Commitment constant, but make minimum payments on all accounts but the highest-interest account (your Target account) which receives all excess payments to pay it off as quickly as possible. After this Target account is paid off, shift your focus to the next-highest interest account, make it your Target, and apply as much as possible to this account while paying only minimums on all others. Continue until all debt is paid off.
Step 4: Create a system for executing your plan
This is where it all comes together and it can be difficult unless you have a good framework to keep you on track.
- Create a monthly spreadsheet to track your repayment. We have included a DebtGoal worksheet to help you execute a Debt Stacking approach.
- Make your payments each month, making minimum payments on your minimum-payment accounts and applying any excess to your highest-interest Target account.
- Adjust your Monthly Commitment for credit card spending in prior months. This is one of the keys to successful debt repayment: if you make payments but continue to charge, you will need a method to adjust for this or you progress will be slowed. To adjust, take any credit card spending from previous months and add this amount to your Target account payment.
Step 5: Advanced techniques
These techniques are not necessary for success, but can speed up your debt repayment.
- Lower interest costs by renegotiating credit card rates or refinancing your mortgage. Studies show that over 50% of people who ask their card issuers for lower rates get their rates lowered by about one-third. If you can lower your rates, be sure to keep your monthly commitment constant–your lower rates will allow even more of your Monthly Commitment to go toward your debt.
- Increase your Monthly Commitment: evaluate and cut your expenses to increase the amount of your Monthly Commitment going forward
- Find one-time sources of cash: consider applying savings to debt or raising money to apply to debt by selling little-used possessions.
- Create a separate checking account to pay your debts Set up direct deposit from paychecks to put the right amount in each month and use this account to “pre-fund” your debt payments. With this technique you won’t have to worry that you won’t have the money to make your debt payments.
This article covers the basics to creating a plan to pay off debt. As with most things, there are several acceptable techniques and it’s important to find one that works for you. Ultimately, the ideal technique for you is the one that makes sense and that you can follow. Above all, commit to a monthly payment that you can dedicate to debt payments each month and track your payments and your progress. Half the battle is just tracking your results-your behavior often follows. As you start on this process, you’ll notice that it’s hard at first but that it grows easier over time.
If you find that tracking and executing your plan manually sounds difficult, try DebtGoal.com, an automated tool to help you create and execute a plan for getting out of debt.
Scott Crawford is CEO of DebtGoal.com, a do-it-yourself system for getting out of debt and lowering your interest costs. DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.
Tags: debt paydown plan, debt reduction plan, Debt Stacking, DebtGoal, monthly commitment, snowball
