The single most important factor in good debt management is to have a plan. It’s one thing to want to get your debts under control but if you don’t have a plan you’re just wishful thinking. Trying to manage your debts without a plan is like attempting to build a house without a blueprint. You may end up with something that looks sort of like a house but the odds are that it will fall down the first time you get a windstorm.
How do I create a debt management plan?
It’s actually very simple. All you need to do is make a list of all your debts along with their balances, the date your payments are due and their interest rates. The best way to do this is with a spreadsheet program such as Excel or Google Docs. When you use one of these programs it’s very simple to then sort your debts using several different criteria to determine the best way to pay them off.
Should I snowball or avalanche my debts?
There are two strategies for paying off debts without having to borrow more money. The first is called the snowballing strategy and was developed by the financial expert, Dave Ramsey. The way it works is that you sort your debts from the one with the smallest balance down to the one with the largest. You then concentrate all of your efforts on first paying off the debt with smallest balance. Once you’ve paid it off you will have more money available to begin paying off the debt with the second smallest balance. The thinking behind this is that if you can get one of your debts paid off fairly quickly this will give you momentum to continue paying off your debts like a snowball gains momentum as it rolls downhill.
Creating a debt avalanche is much like snowballing your debts except you pay off the debt that has the highest interest rate first. This will save you the most money though you will not build momentum quite as quickly as with the snowballing strategy as it could take you longer to pay it off.
Which of these would be better? There are ardent supporters of both these strategies. So it probably boils down to the one you like the best.
Is a debt consolidation loan a good way to pay off debts?
There are both pros and cons to this. The biggest pro is that the debt consolidation loan should have a dramatically lower monthly payment than the sum of the payments you’re now making. This is due to two factors. First, it should have a much lower interest rate than your current debts – especially credit card debts – and second, you will have much longer to pay it off. However, this can also be a con. For example, if you were to refinance your home and use the money to pay off your debts, you would have a new 15-or 30-year mortgage to pay off. And even a home equity loan would probably have a 10-year payoff.
Consumer credit counseling could certainly help you get your debts under control and paid off. In fact, if you were to go to a consumer credit counseling agency, they would develop your debt management plan for you. In addition, they would present your plan to all of your creditors for approval. Assuming they did approve it, you would no longer have to pay them. Instead, you would send a check each month to the credit counseling agency and it would distribute the funds to your creditors. The upside of credit counseling is that if you stick to your debt management plan, you should be debt-free about five years. The downside is that you would have to give up all of your credit cards and learn to live on a fairly strict budget.
What is debt settlement?
Debt settlement is another good way to do debt management. Companies that specialize in debt settlement are usually able to get debts reduced by thousands of dollars to help their clients become debt free in two to four years. This is also a form of debt consolidation in that once the company has settled all your debts; you would no longer be required to pay your creditors. Instead, you would pay the debt settlement company once a month. However, there is a downside to this option, which is that debt settlement would definitely leave a black mark on your credit reports.
Does it ever make sense to declare bankruptcy?
If you are so deeply in debt that you don’t believe any of these options could help then filing for a chapter 7 bankruptcy could make sense. It takes only about six months to get through a chapter 7 bankruptcy and you should be able to get an attorney to handle it for $500 or even less. If the court approves your application for a chapter 7 bankruptcy, you would see all of your unsecured debts discharged. This would include credit card debts, medical bills, personal lines of credit, and personal loans. However, not even a chapter 7 can get rid of student loan debts, child support or alimony or secured debts such as a mortgage or auto loan. A chapter 7 bankruptcy would definitely leave a black mark on your credit report that would last for as long as 10 years. You would find it very difficult to get any new credit for the first two to three years after the bankruptcy and when you were able to get credit it would come with a much higher interest rate. However, if you can’t see any other possible way out of debt then declaring bankruptcy is certainly worth considering. You should also watch the following video as it discusses the two phases of a chapter 7 bankruptcy, including what your life will look like afterwards.