It takes discipline to make a household budget—and even more discipline to stick to it—so consider these five tips to help you turn 2014 into a debt-free year:
1. Take stock of your financial situation.
Before you start knocking out your debt , you’ll need to determine exactly how much money you owe and on which accounts you owe it. Make a list of all of the debt you owe on your credit cards and loans, as well as the interest rates that you’re paying. Don’t forget about old credit cards or retail cards that you no longer use but on which you still carry a balance.
To ensure that you’ve accounted for all of your debt, pull a copy of your credit report and carefully check each credit account. You can order one free credit report every 12 months from each of the three national credit reporting agencies at annualcreditreport.com.
As you look over your credit reports, consider your debt-to-income ratio. Experts agree that you can generally afford to pay between 28 percent and 36 percent of your gross income in debt service. This means that, ideally, if you add up all of your debt—including payments on your mortgage, student loans, auto loans, and credit cards—it should not exceed 36 percent of your gross monthly income.
2. Create a spending plan.
Start by writing down all of your weekly, monthly, and yearly expenses, and then prioritize them to see where you can cut back. Determine which items are “needs,” such as food and gasoline, and which can be classified as “wants,” such as new clothes and meals out at fancy restaurants.
Once you’ve shaved some expenses from your balance sheet, decide how much of your savings can be put towards paying off your debt. You may also choose to dig into annual bonuses, holiday bonuses, and tax refunds in order to pay off some of what you owe.
3. Pick a payment strategy that works for you.
Decide how you want to prioritize your debt and then list all of your accounts in the order that you’ll pay them off. You can prioritize them by the amount of the balance, the interest rate, or both.
If you decide to prioritize by interest rate, focus on paying down the debt on the account with the highest interest rate first. Remember, though, to continue to pay at least the minimum balance on all of your other accounts. Once your first account is paid off, take the money that you were spending on it and put it towards paying off the account with the next highest interest rate—and then move down your list of debt accordingly.
However, if you have a small debt on one account—even if it doesn’t boast the highest interest rate—consider paying it down quickly. This could help you gain momentum and provide you with funds that can be redirected to paying off your larger debts.
Remember: Paying off a credit card doesn’t mean you have to cancel it. Your credit utilization—or how much of your available credit you use—is one factor that helps determine your credit score. By leaving your credit cards open, you’ll keep your maximum available credit as high as possible. This could positively impact your credit score by keeping your ratio of debt to available credit low.
4. Negotiate interest rates with creditors.
Ask your creditors if you qualify for a lower interest rate, especially if you’ve consistently made on-time payments and have paid at least the minimum amount.
5. Regularly track your spending—and make adjustments as needed.
To stay on pace for getting out of debt in 2014, continue to monitor your spending every month and quarter, and fine-tune your spending and savings plans if necessary. If you make it a point to record all of your expenditures, it should help you keep track of how you’re using—or wasting—your money.
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