What Is the Best Way to Eliminate Debt?

Dealing with large amounts of debt can be stressful. Debt takes a toll not only on your consumer credit file, but also on your wallet. You lose money every time the majority of your minimum monthly payment goes toward interest instead of principle. When eliminating debt, start with a plan of action and continue your efforts until you are debt free.

Interest Rates

One of the best ways to eliminate debt is to pay off higher interest credit accounts first. Financial expert Suze Orman suggests putting your credit accounts in descending order from highest to lowest interest rate and paying off your debts accordingly. As you pay down one account, make payments on your remaining accounts. After you completely pay off a card, apply the money you normally would pay toward that account to your next account. Continue this pattern until you are debt free.

Debt-to-Income Ratio

The best indicator of how well your debt reduction efforts are progressing is the rate at which your debt-to-income ratio is shrinking. Debt-to-income ratio is a comparison between the amount of money coming into a household and the amount going out for debt payments. To calculate your debt-to-income ratio, add the total amount of your debt. Divide this result by your monthly income. As you start the debt repayment process, your debt-to-income may reach as high as 15 to 20, which is least favorable; however, as you pay down debts, your debt-to-income ratio could dip as low as 15 percent or less, which is the most favorable.

Debt Relief Programs

Credit counselors and debt management firms offer numerous programs to help debtors climb out of debt. If debt consolidation or loan modification is not right for you, speak to a credit counselor about negotiating a lower interest rate, so more of your debt payments go toward principal, not just interest. The National Foundation for Credit Counseling estimates credit counseling fees at $50 for a set-up fee and $25 for a monthly service fee.

Debt Settlement

If you cannot budget a way to repay your debts, enter into a debt settlement agreement with your creditors. Debt settlement offers a legal way to settle debts at 20 to 90 percent of their original value. Creditors typically do not accept debt settlement offers for accounts that are less than 90 days old. When negotiating, start low and work your way to a settlement offer you can reasonably afford to pay. One of the consequences of debt settlement is a drop in credit score. Barry Paperno, consumer operations manager at FICO, says, "It is considered negative to the same extent as a charge off or an account included in bankruptcy or repossession or something of that nature in which the lender took a loss on the debt."