Effective debt management is critical for financial success, as you save money on current interest expenses, while also positioning yourself to negotiate low interest rates on future debt. For motivation, the process of debt management begins with an outline of your financial goals. From there, you can analyze your current assets and cash flow to begin making strategic debt payments according to interest rates.
Identify Financial Goals
Define and prioritize your financial goals before initiating the process of debt management. Common financial goals include saving up money for a first-time home purchase, tuition costs and ultimately, retirement. Your goals should be broken down further according to a time frame and total costs. For example, you may need $2 million to retire to a South Florida condominium in 30 years.
Recognize that your financial goals may never materialize, if you cannot get your debt and interest expenses under control. As part of your financial plan, you may set a goal to eliminate all credit card debt within the next two years.
Good vs. Bad Debt
As part of your debt management plan, you must learn to differentiate between good and bad debt. Good debt is leveraged to buy assets that create wealth, and often features low, tax-deductible interest payments. Mortgages and student loans are examples of good debt. Alternatively, bad debt is used to purchase consumer goods, which do not add value to your bottom line. Bad debt typically includes credit card balances that feature high interest rates. Effective credit management calls for you to keep bad debt to a minimum.
Personal Debt Inventory
Order a copy of your credit report---to take inventory of your current debt and credit history. TransUnion, Experian and Equifax are the three major credit-reporting agencies that help the Fair Isaac Corp. to calculate your FICO score. As part of the Fair Credit Reporting Act, you may order one free credit report per year through AnnualCreditReport.com. The credit report organizes debt according to lender, type, balance and your ability to make timely payments.
With the credit report information in hand, you should further list each debt according to interest rates. From here, you should make the effort to contact each lender in an attempt to negotiate lower interest rates on current debt. Credit card companies are often open to lowering interest rates for good customers.
Analyze Current Assets
Review banking and investment statements in order to locate cash flow that can be spent to pay off debt. Bank deposits and investments that pay out minimal returns should be viewed as a source of lump sum cash that can reduce debt.
To calculate monthly cash flow, you will subtract your monthly expenses away from your monthly income. To improve your available cash flow, you may consider lowering your current living standards and putting in more time at work.
Debt Payments
Prioritize debt payments according to interest rates. To save money, you will make minimal payments on low-interest rate debt, so you can preserve cash flow to first pay off the most expensive debt.
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