Debt Reduction - 101

Hello! David J here again bringing you more of the steps on my journey toward financial independence.

Wanted to share some insights on the topic of debt reduction I've picked up along this journey.

The first comes from a Multi-Level Marketing company I hooked up with back when I was first laid off, back in the fall of 2009.

To get on track toward your debt reduction goals, you first need to assess what you owe and what are the interest rates on those accounts. Order them first by the lowest balance, then by the highest interest rate.

The first goal is to achieve the first pay-down.

"Pay-down"? Don't you mean "pay-off"? Well, not quite. We'll discuss that in more detail in a moment. For now, let's just focus on that account we can knock down easily because it has the lowest balance.

What you want to do is pay above the minimum on all your accounts except your house payment. Most of all, you want to figure out how you can pay down the lowest balance first as soon as you can possibly get it paid down.

Once you get that first balance knocked down to 10% of where it was when you started your pay down plan, pull this payment back to the new minimum payment and apply the surplus to the second account on your list. If you can, pay $100 plus the amount of finance charge on the current statement. If that's too much to handle, do what your budget will allow, but by all means do as much as you can to knock these debts down - they're literally killing you, financially!

In fact, if you can, pay the minimum payment plus $100 or more. It will be uncomfortable while you're working your way out of the hole, but you'll feel SO good when you're done!

Do the same when you've paid the second account down to 10% of the balance it had when you started your pay-down plan: pull the second account payment back to the new minimum and apply the surplus to the third account. Again, pay at least $100 plus the amount of finance charge on the current statement, if you can, or the minimum payment plus $100 or more. This should be getting easier as you knock these balances down.

...and so on. The technique is called "debt stacking". You pay the same amount toward your debts every month, even as accounts get paid down. You just shift money around so it goes toward the next highest balance or interest rate account.

Now: Why "Pay Down" and not "Pay Off"?

Well, perhaps anecdotal evidence will explain it better than I can.

I recently commented on an article in an on-line publication regarding the topic of credit. I saw a post from a fellow calling himself, "Justin".

“Justin” posted, “had about 8K on credit cards, always paid on time, never had any credit issues, I was paying it down slowly (leftover college debt), then I came into some money (overseas assignment) and paid it all off in about 3-4 months. I thought, wow this is gonna be good for my credit...wrong! All the credit card companies cancelled my cards and said I was a credit risk. I had a mid 700 credit rating, well paying, solid job and always paid on time. Makes absolutely no sense to me, any insight?”

A fellow calling himself "Peter" chimed in.

“Peter” responded, “Yeah, if you have no debt, the bank isn't making money. Therefore why should they give you a credit card?”

This was my response:

While Peter kind of missed the mark, the essence of his thought was valid. I'm guessing Justin’s creditors got nervous from the sudden, radical change in his fiscal habits.

Bankers can't handle radical changes - they're greed-driven, not rational. They will always assume the worst (picture the comic-strip character with his own private storm cloud over his head). Best to break it to them gradually, no more than 10% per month of your starting balance when you begin the payoff, then carry a small balance - say, 10% of what you had before you paid it down, just to show them you're still a reliable source of income.

I know, should we come into a large sum of cash, there's a tendency to want to "cast off the shackles of yesterday" and run free. I'd like to do that myself, actually.

I do have some personal financial issues - not related to credit - I will want to dismiss with the first big payouts I get from my entrepreneurial pursuits. No bankers involved there, so I'll clear those up post-haste.

After that, though, I'll begin a gradual reduction in my credit utilization so it becomes clear from my credit report that I became able to reduce my balances without appearing to be "spending wildly" or indicating huge changes in my fiscal habits.

I will, of course, resume building and then begin using the credit of my LLC, so large expenditures and subsequent payoffs do not appear on my personal credit.

Your comments are always welcome!

We'll talk again soon!

Take care - be well!

Much Success!