In this series of articles, you will be able to follow along at your own pace as you work to bury the debt monster and regain complete financial control. Whether you were like a child in a candy store or you simply spent a little more than you made every month over a long period of time, your debt can be crippling- and effect all other aspects of your life. Use this series of articles to turn it all around!
Lesson One: Opening Your Eyes
Many people don't know how much debt they have, and whether or not they have a good balance of "good" and "bad" debts. Most people who have the most debt try to ignore the extent of debt they are in- in other words, they avoid reality because what you don't know doesn't hurt you, right? In this case, unfortunately, debt always hurts you over the long term!
The first lesson on the road to self-debt reduction or elimination is to understand how much debt you actually have, and what type of debt it is.
Make a List
Let's start with the "bad debts", since these are the ones we will want to pay off as soon as possible. Bad debts include store credit cards, car loans, and charge cards- any purchase that loses value instead of offering you potential earnings.
On a piece of paper or on a computer spreadsheet, set up your list like this:
Name of Card/Loan Amount Owed Interest Rate Estimated annual interest
Ex: Citibank $2,123 18.36% 2123 x .1836 = $389.78
Next, do the same thing for good debts. Good debts are things like school loans, mortgages, second mortgages, and other investments that may earn money. We will use your good debt list in a future lesson, but for now, let's take inventory of everything you owe on two separate lists: "bad" and "good".
Analyze Debt to Income Ratio
Once you have both your lists completed, you'll want to analyze the amount of bad debt you have. Get a total amount of the "amount owed" column of your bad debt list and compare it to your annual after-tax income. The bad debt total should not be a large chunk of your income. You can find your debt to income ratio (and we're just dealing with bad debt at this time) with a simple formula:
Total Bad Debt / After-tax income = bad-debt-to-income ratio
If you're total bad debt is $5,770 and your after-tax income is 36,000, you would have a bad-debt-to-income ratio of 16%. The goal is 15% or less in order to keep your payments manageable.
How Much You Actually Flush Down the Drain
Now, for a real eye opener, add up the amount of estimated interest you pay annually on your bad debt accounts. WOW! While student loans or mortgages are considered debt worth paying interest for, look at how much money you are flushing down the drain each year on your credit card and car loan payments. Think about what you could do with that extra money on an annual basis!
Lesson one has probably been an eye opening experience overall for the majority of you. The first step for alcoholics and drug addicts is to admit they have a problem- the first step for people looking to get out of debt is to face the debt monster and see exactly how much money they owe. The next lesson will lay the foundation for eliminating the worst of our debts: credit card debt.
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