Get Out of Debt Before Debt Takes It Out of You

Without debt, it would be tough to buy a house or your first car. Not many of us can rack up $100,000, $200,000, or more to buy a house free and clear. With debt, you can definitely have too much of a good thing. Mortgage payments, car payments, and credit card minimum payments are due every month, no matter what. If you borrow too much, you might not be able to save any money after buying food, paying taxes, and making debt payments. When things get really out of hand, you might end up borrowing money to buy food and that will simply end badly. Even if lenders are willing to loan you more money, it's a good idea to keep your debt load under control. If you find out you're over the edge of excessive debt, you can use common sense, discipline, and online tools to get back on track.

Keeping Debt in Check

When you shop for a mortgage or a car loan, lenders typically check your debt to income ratio to figure out how much they're willing to lend to you. Credit card companies, on the other hand, want you to run up balances on your credit cards. With rates as high as 21 percent, they rake in the dough when you maintain a balance. Paying only the minimum monthly payment on a credit card can take years to pay off the balance, and the interest you pay could end up being more than you borrowed in the first place.

So, what are these guidelines that lenders follow?

Mortgage debt to income ratio

Bringing Debt Back in Line

If your debt ratio is a little higher than the lenders' guidelines, you can whittle it back down with some minor adjustments to your spending. Often, you can get back on track by putting your credit card in a drawer for a while. Studies show that many people don't view credit card purchases as spending real money. Try paying cash or writing checks to bring your spending back to reality. You can also replace your credit card with a debit card, so that you have to pay it off every month.

If you can only afford to pay the minimum on your credit cards each month, you can resort to using cash advances on one card to pay another, or mailing the wrong checks to creditors to buy some time. At this point, you'll need stronger measures to get back on track. Here are some techniques to reduce your debt as quickly as possible with the minimal amount of pain:

Pay off debts with the highest interest rate first. For example, if you carry a $5,000 balance on a credit card charging 20 percent interest, pay as much as you can afford each month on that card, while paying the minimum monthly payment on your 8 percent credit card. When the 20 percent card is completely paid, use the monthly payment you were making to start paying off the 8 percent card. When that card is completely paid, apply the monthly payment to paying off the 4 percent home equity loan.

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After your debts are paid, you can apply the monthly payment you're accustomed to dishing out now to savings.

Stop contributing to savings until your high-interest debt is paid off. Paying off a 20 percent credit card interest by foregoing 1 percent on savings is like a guaranteed 19 percent return on your money—which is a good return even for investing in the stock market.

If you carry a lot of debt, consider paying it off with some—but not all—of your existing savings.

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If things are really bad, you can even stop contributing to your 401(k). Because 401(k)s have other benefits, such as reducing your taxable income and employer-matching, you should halt your 401(k) contribution as a last resort.

If you want to know when you can start buying grande caramel skinny lattes on your way to work again, you can prepare a more formal debt reduction plan using the debt reduction calculator at http://www.quicken.com/planning/debt/debt_planner. Before you go online, search your filing cabinet to figure out how much you have in savings and identify the interest rate, outstanding balance, minimum monthly payment, and your typical monthly payment for each of your credit cards, mortgages, home equity loans, second mortgages, car loans, any other installment loans, and other debt.

After you enter the information about your debts, the planner tells you how long it will take and how much it will cost to pay off your debt on your current schedule. If you want to apply savings toward paying off your debt, select the Savings tab, type the amount of savings you want to use, and click Save/Recalculate. To find out what steps to take to make your plan happen, click Action Plan. The planner includes common-sense tips such as stop charging to credit cards, but also tells you how much to pay to each creditor each month to optimize your monthly debt payments.

On the other hand, if lack of self-discipline got you into this mess in the first place, you might want more help than the Quicken planner can provide. Debt Counselors of America is a not-for-profit organization that can help you for a small fee. You can download their publications from http://www.dca.org or contact them to get one-on-one help. Their One-Pay service includes working with creditors to reduce monthly payments, late fees, and interest. You make one monthly payment to DCA and they handle payments to your creditors.

Keeping Debt in Check

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Bringing Debt Back in Line

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