Commentary: Pay down debt to get ahead of the credit monster

St. Louis Daily Record & St. Louis Countian, Jul 2, 2005 by Dena Frenkel

(This article originally ran in The Daily Record, Baltimore, MD, another Dolan Media publication).

In the spirit of giving, it's easy to overspend during the holidays. The bad news is that the additional debt incurred over the holidays may have furthered your financial burden well into the new year.

According to the Federal Reserve, Americans have nearly $700 billion in credit card debt rolling from month to month. Furthermore, the Cambridge Consumer Credit Index found that about half of that amount is being reduced by only the required minimum monthly payments.

Strive to find a new approach to managing money and resolve to take the following steps in the second half of 2005 to get yourself on track to be debt-free:

Assess debt: Make a list of your credit card bills and all minimum payments due as well as the amount of interest owed on each account. Calculate the minimum amount due every month and your total debt. If you have adequate savings to cover the debt, pay it off (especially if your savings are sitting in a low-yielding bank account or money market fund). Paying off high-interest debts is better than earning low interest on your savings.

Create a repayment plan: If you can't pay off debts immediately, compare your minimum monthly card payments to your discretionary income. If your discretionary income is higher than your minimum payments, use the extra cash to begin paying off the debts. The most efficient way to pay down balances of loans or credit cards is to first tackle the ones that charge the most interest, while paying at least the minimum due on all your other debts. Once the card with the highest interest debt is paid down, work on the next one, and so on.

If possible, carry only one credit card - preferably one with a low monthly interest rate. If you carry substantial high-interest debt, consider consolidating balances with a lower-interest, potentially tax-deductible home equity loan. As a rule of thumb, pay more than the minimum amount due on all debts. If you just pay the minimum, you'll barely cover the interest you owe and, in the long term, end up spending thousands of dollars more than the original amount you charged. Also, be cautious if borrowing money to cover your debt. Borrowing against your home or 401(k) to pay off your debt can place you in danger of losing your home or retirement savings.

Trim spending: If you don't have enough discretionary income to cover your bills, you'll have to cut your expenses. Take some time to create a budget by calculating your monthly expenses. Look at your discretionary spending, and try to find ways to cut back (e.g., eating at home rather than at a restaurant).

Look for deals: While you're focusing on paying down debt, now may be a good time to look for better deals on monthly expenses, such as cell phones or long-distance service. Also look for discount prices associated with everyday expenses, such as groceries, dry cleaning, etc. By taking the time to look for bargains, you'll free up cash to pay down your debt.

Stash some cash: Even though you may be focused on paying down debt, do not neglect your cash reserves. As a rule, you should have at least three to six months' living expenses set aside and available as cash in case of an emergency. If you don't have any reserves, even a minor emergency may further upset your finances.

Stay on track: Once you've made paying down debt a priority, try not to incur anymore credit card debt. Ideally, you should try to get to a point where you can pay off your balance in full every month. If you have to carry a balance, confine it to one card with the lowest interest rate.

Develop a long-term plan: Tackling your debt is the first step to finding financial success. To make sure that you have a grasp on your total financial picture, you need to develop a plan. A qualified financial adviser can help you set realistic, long-term goals for debt repayment and other financial objectives.

Dena Shapiro Frenkel is with American Express Financial Advisors.