In America today, carrying some debt is unavoidable, and even desirable, for most households. But between mortgages, car payments, and credit cards, many Americans find themselves over their heads - unable to dig out from under a growing debt burden that consumes an ever growing portion of their resources.
The median U.S. household owes $3,000 in credit card debt.1 Credit card companies have made running up that balance deceptively convenient. What's lost when you're on that spending spree is the realization that paying off your debt can be costly, in terms of both cash on hand and your overall financial health.
How much debt is too much? The figure varies from person to person, but in general, if more than 20% of your take-home pay goes to finance nonhousing debt or if your rent or mortgage payments exceed 30% of your monthly take-home pay, you may be overextended.
Other signs of overextension include not knowing how much you owe, constantly paying the minimum balance due on credit cards (or worse, being unable to make the minimum payments), and borrowing from one lender to pay another. To help judge your personal situation, fill out the Debt Assessment Worksheet below.
If you find that you're overextended, don't panic. There are a number of steps you can follow to eliminate that debt and get yourself back on track. Working your way out of debt will, of course, require you to adjust your spending habits and perhaps be more judicious in your spending.
The first step in eliminating debt is to figure out where your money goes. This will enable you to see where your debt is coming from and, perhaps, help you to free up some cash to put toward debt.
Track your expenses for one month by writing down what you spend. You might consider keeping your ATM withdrawal slip and writing each expense on it until the money is gone. Hang on to receipts from credit card transactions and add them to the total.
At the end of the month, total up your expenses and break them down into two categories: Essential, including fixed expenses such as mortgage/rent, food, and utilities, and nonessential, including entertainment and meals out. Analyze your expenses to see where your spending can be reduced. Perhaps you can cut back on food expenses by bringing lunch to work instead of eating out each day. You might be able to reduce transportation costs by taking public transportation instead of parking your car at a pricey downtown garage. Even utility costs can be reduced by turning lights off, making fewer long-distance calls, or turning the thermostat down a few degrees in winter.
The goal is to reduce current spending so that you won't need to add to your debt and to free up as much cash as possible to cut down existing debt.
Once you've got your budget settled, you can begin to attack your existing debt with the following steps:
1Source: U.S. Census, 2011 (latest available).
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