To get out of debt, it always helps to know what happened and to be honest with yourself about where you are and where you want to be. My previous article in this series addressed that topic.
Now it is time to figure out where you are exactly, which means writing down the details. Make a list of all your debt, and list the amounts (the balance) and interest rates for each. You should prioritize what debt you want to attack first. Some people recommend paying off the debt with the highest interest rate first while others recommend starting with the smallest balance and continue moving from smallest balance to largest balance.
Highest Interest Rate Method
This method works in your favor mathematically. Over time, your debt with a higher interest rate will cost you more than debt with a lower interest rate because of the interest charges. If you are able to pay this off first, freedom from these high interest rates will help you tremendously. If you are motivated by numbers, this method may be best for you.
If your highest interest rate debt is also your largest debt, it may be difficult to see progress for a while, which can be disheartening.
Lowest Balance Method
This method works in your favor psychologically. If you are less motivated by numbers, you may prefer this method, which is to start by paying down your smallest debt (the one with the smallest balance). This is sometimes called the “snowball method” of paying down debt. The advantage of this method is that you can see progress more quickly by eliminating small debts. The hope is that you gain momentum as you have fewer debts to pay off and you see fewer debt line items in your budget.
The downside of this method is that your smallest debt may not be the debt with the highest interest rate. This means you will pay more over time.
You can also try a hybrid model, where you split the money you are paying off between the debt with the highest interest rate and the debt with the smallest balance. You will be able to knock out the smallest debt a little more quickly, but you will also work on getting rid of the higher interest rate, which helps you in the long run.
No matter which method you decide to go with, be sure you are still making minimum payments on all your debt in the meantime. You do not want to get yourself further into trouble. And you can always change directions later if your method is not working.
Track Your Spending
The next piece of assessing your situation is tracking your current spending. You need to know where your money is going. One common problem is under-estimating how much you are spending and where you are spending it. You may not have a budget (which we will address in Part 3 of this series). For now, whether or not you have a budget, I recommend at least tracking your spending so you know where your money is going. Armed with that knowledge, you will be able to make a concrete plan.
There are many budgeting programs and phone/tablet apps that you can use to track your spending. Some, like Mint and Level Money, import transactions from your bank accounts and credit cards. Then you categorize your spending. Others, like You Need a Budget and Expenses Ok (or a spreadsheet program like Excel), do not connect to your accounts and instead rely on your to enter your spending manually.
There are pros and cons to each method. If you are worried that you will forget to enter data, you may want to try one of the programs or apps that import your data automatically. If you are concerned about giving an app access to your accounts, choose one of the manual entry options. For sheer awareness of every cent you spend, nothing is better than one of the manual entry methods. You may want to use a hybrid model (or some software such as Quicken allows imports of financial account data). At least make sure you reconcile your statements at the end of the month so you don’t miss anything.
Once you know where your money is going, you can make a plan and adjust your spending.
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