Credit and Debt Management
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Monitor Your Credit Report Regularly
Keep in mind that recent legislation entitles individuals to recieve free copies of their credit report from each of the major credit bureaus annually. Reviewing your credit on a regular basis is beyond advisable- it's imperative. Doing so will alert you to both mistakes and possible criminal activity that could result in the theft and misues of your identity. Identity theft is a critical issue today and you can really never be "too careful."
Learn the Rule of 72
A critical principle in personal finance called the Rule of 72 should be learned immediately. Stop and do not progress in your learning about any other related topic until you know this critical and really very simple mathematical model representing how compound interest works.
Why should this matter to you or to me? That's easy. If we are paying credit card interest or interest on another loan we should understand how quickly that balance is compounding against us. The Rule of 72 can also act in our favor and understanding it will allow us to estimate how long it will take an invested balance to compound in our favor.
Simple Example(s):
If you pay 10% interest per year on a balance you owe, the balance owed will double against you approximately every 7.2 years. That figure of 7.2 years is the result of dividing the interest rate by 72 (i.e. 72\10 = 7.2). You can do this simple equation for any interest rate and you will learn approximately how long it will take a given sum to double for or against you.
You can also use the rule to your advantage when you save and invest money rather than borrow it! At 18%, money doubles for or against you every 4 years. At 9%, money doubles for or against you every 8 years. Understanding the Rule of 72 is fundamental to our daily decision making and makes the decisions involved with how to manage, liquidate and retire our debt much easier as well.
Apply "The Snowball Principle"
Since the rates paid on our debt are directly related to how quickly the balance of our loans will double against us, let's state a general principle now for selecting how and in what order to pay off multiple debt balances. Generally speaking, we will want to concentrate on accelerating the payoff of the balance with the highest annual interest rate charged (regardless of the size of the balance) since that particular balance is the one accruing against us the most rapidly. Now you've got it.
By way of repetition and emphasis, the critical issue here is slowing down the "velocity of the money" as it accrues against us- irrespective of the actual dollar amount owed.
Assume:
- Credit Card #1, $5000 owed, 18% annual interest rate, $63.00 monthly payment
- Credit Card #2, $2300 owed, 24% annual interest rate, $53.00 monthly payment
- Credit Card #3, $1500 owed, 29% annual interest rate, $47.00 monthly payment
You now have the principle on which to determine how to attack the debt you may have already incurred. Don't get hung up on paying off the biggest balance first to free up the largest payment amount. Though that seems the intuitive thing to do, you are ahead to follow the rule stated above. Therefore, pay the minimums on all cards but put any additional cash available to work chopping down the balance that is accruing most aggressively against you at 29% (i.e. doubling against you every 2.48 years).
Once you pay off the balance accruing at the highest rate you can combine that minimum payment amount and the extra cash you were using to accelerate its payoff and add all of that extra cash to the minimum payment of the next highest rate balance. In this way you will effectively "snowball" or accelerate the payoff of the aggregate balances you owe most quickly and efficiently with the least interest expense incurred out of pocket.
Credit Counseling
Credit Counseling is available and can be useful if and when the cash flow is insufficient to apply the technique described above. Be careful, however, as not all credit counseling sources are reputable. Learn more about credit counseling
Your credit is an increasingly critical component in the process of landing a job among several other important life wellness factors. Employers are now checking credit in most cases in the employment process.
See also: The ABCs of pre-employment background checks.
Bankruptcy
Though the option of bankruptcy is rarely the best choice, if you're considering it, talk to us before you make any final decisions. There are serious ramifications regarding this step that you should be aware of if you are considering such a step.
Check this article from Consumer Affairs for more information.
Other Questions
You may have several other questions. Visit us. You'll be glad you did!
