Reducing debt may not be your first priority until you find yourself facing financial troubles due to overspending or poor money management. Lenders use basic guidelines when reviewing your finances and, if you exceed recommended limits for each category, you are likely to be denied further credit. And, if you keep letting your debt snowball, you can seriously damage your credit score and may face the possibility of foreclosure or bankruptcy.
You should begin taking steps toward regaining control of your finances as soon as possible so you can avoid more serious problems in the future. Reducing debt is easy by using a few basic guidelines and debt calculations to allow you see when your debt load is getting into the danger zone. Some financial knowledge and understanding will help you make smart decisions and build a secure future.
1. Track Your Spending
Making a budget is one thing, but sticking to it can be something else entirely. Budgets tell you how money should be spent – tracking your transactions will show you how it was actually spent. The first way to get your finances under control is to know where you money is going and make the adjustments needed to get out of debt.
Keep your receipts and records of any cash withdrawals so you can compare them with the amounts indicated in your budget. You may be shocked at how much you are actually spending. Depending on the flexibility of your finances, you may have to decrease your spending or increase the amount allotted to specific areas. For example, if there is no way you can reduce your transportation costs, you may have to increase this portion of your budget and find another area where cuts can be made.
There are many options for tracking your spending. You can use paper-based ledgers, software on your computer, internet programs, or apps for your smartphone. Here are a few products we’ve tested that we are happy to recommend:
If you love spreadsheets, you will love the budget spreadsheets offered by Vertex 42. Some are even free and all of them are easy to download!
2. Debt Income Ratios
The second step in managing your debt is calculating your debt income ratio. This is the amount of your monthly net income (take home pay) that you use for re-paying debts. Unfortunately, statistics show that about 43% of Americans spend more than they make and this can lead to serious financial struggles, especially with high interest credit cards.
To calculate your debt to income ratio you divide the amount needed to pay your debts each month by your take home pay.
A debt income ratio of 30% or lower is considered excellent while 40% or higher will likely make it difficult for you to obtain credit. Lenders will use this figure to determine your creditworthiness so your goal for getting out of debt – and staying out of debt – should be to keep this percentage within an acceptable limit. To learn more about this ratio, please click here. To use our free calculator, click here.
3. Credit To Debt Ratio
This is a very important aspect of your FICO score and will greatly impact your ability to get credit. The credit-to-debt ratio looks at the amount of debt you have in comparison to the amount of credit available to you.
Having a $1,000 balance on a credit card with a $10,000 limit is better than owing $3,000 on a card with a $5,000 limit. So, don’t cancel the credit card once you pay off the account. You are smarter to keep a card you don’t use than to get rid of all your available credit. When it comes to getting a consolidation loan or using another debt relief option, a lower credit-to-debt ratio can be helpful. To learn more about this ratio, please click here.
4. Pay Yourself First
Most people find that once they have paid all their bills there is nothing left to put away. In fact, according to a survey done by CNN Money, 28% of Americans have no savings whatsoever.
Although it sounds a little strange, paying yourself first is essential to financial success and protecting your future. Always put something away in your savings and leave it alone unless it is an absolute emergency. Even $5 a week can make a big difference and will help you develop a habit of prioritizing saving.
5. Snowball The Credit Cards
Interest can add up to thousands of dollars over the course of your lifetime, and you can significantly relieve a tight budget by eliminating high interest debts.
Choose your highest interest credit card and commit to paying a little extra above the minimum required payment each month. Even $10 extra can cut your payment term in half, if not more, and greatly reduce the amount of interest you will pay in the long-run.
The Power of Financial Knowledge
A lot of people do not give the health of their finances enough attention until it is too late. But, you don’t have to be a financial whiz to understand your credit and debt situation. With just a few simple calculations and an eye on the future, you will be able to achieve financial success and keep your debt under control.
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