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How to Dig Yourself Out of Debt and Save at the Same Time

Wherever you might be financially, getting ahead can feel like it's beyond reach. Current bills can seem to gobble up almost everything. Unexpected ones seem to crop up whenever you have a little extra cash.
Chances are, you find it difficult to do anything because you don't know where to start. Relax. A lot of people are in your situation. What you need to do is face up to the matters at hand and set up a plan of action. The time to do that is right now. With a little self-discipline and some faith in yourself, your financial picture can potentially change for the better in about six months.

Paying Debt and Saving

What should you do first? Reduce your debt or start saving? The following three-part strategy may help you control your cash flow, pay off your debt, and encourage saving so you can handle the unexpected expenses that may have gotten you into debt in the first place. In time, you'll be ready to invest. But first you have to know what you owe and what you're spending.

Tracking Spending

The steps outlined in the box below will help you determine how much cash you have to pay off your debt.
Next, you'll want to keep track of your typical expenses for one month or so to find out where your money is going. Also figure your unexpected expenses for a year's time — auto and home repairs, gifts, vacations, etc. — and divide that number by 12. You may want to use one of the personal finance software programs available to track your spending. Once you have a record of your spending, compare your monthly outlay with your monthly income. If you have a surplus, this is the amount you can apply each month to paying down debt and building savings. If you have a shortfall, you'll need to cut expenses.

How Much Do You Have to Pay Off Your Debt?

Step #1: Create a personal balance sheet and list your debts in order of interest rate, from highest to lowest.
Step #2: Add up your liquid assets, including savings and investment accounts, if any.
Step #3: List any major purchases needed in the next year. Subtract this amount from your liquid assets. What remains is the amount you may have to pay your debts.

How to Build Savings

A key to establishing good saving habits is to make saving even easier than spending. Here are some tips.

  • Ask your bank about linking your savings and checking accounts via an ATM card. Set up three savings accounts with goals attached to them. One may be labeled "cushion" for emergency cash, a second for "expenses" for unexpected bills, and a third for "investments." Carry your card only when you really need it to make transactions, and withdraw only what you need for one week. Then you won't be tempted to take out cash for impulse purchases.
  • Whenever you're paid, put only what you need to live on for one month (or two weeks, if you get paid every two weeks) into your checking account. (If you put more into checking, you'll probably spend it.) You may want to consider keeping some additional funds in your checking account as a “margin of error” to help avoid overdrafts.

  • If you can, put money equaling one month's expenses into your expenses account for unexpected bills. The idea is to build at least a small stash so you're less likely to use your credit card if your car needs a new tire.
  • Begin building your emergency cushion by depositing a portion of each paycheck into your “cushion" savings account. If your goal is to have three months' living expenses, you could reach your goal in 30 months by saving 10% of each month's pay — or in 15 months by saving 20%.
  • Put whatever is left into your "investments" account, including found money such as birthday and holiday checks, bonuses, or money made from a garage sale. If you get a raise, put the difference into this account on a regular basis.
  • If your bank can't link your checking and savings accounts, or if you find it hard to control your spending when access to your savings is easy, ask your employer about direct deposit. You can have money taken from your paycheck and placed in a savings account automatically.

How to Reduce Debt

Paying off debt is easier once you stop using your cards.

  • Pay off your highest interest credit card debt first, making sure you avoid the "minimum balance trap." Because credit card companies make their money from interest payments, they purposely set those payments low so it will take you years to pay off the balance. Paying just a little more than the minimum can make a big difference. For example, assume you have a balance of $5,000 at an interest rate of 15% and you make the minimum monthly payments of 2.5% of the balance or $25, whichever is greater. It would take you 183 months to pay off the debt and cost you $4,395 in interest. However, if you were to pay an extra $150 each month, you would pay only $845 in interest over 27 months. This is a hypothetical example for illustrative purposes only.
  • Consolidate your debt by transferring outstanding balances to lower-rate cards. These days, the competition between credit card issuers is so intense that you can often negotiate your interest rate. If you don't want to transfer your balances, chances are that your current credit card company will match the interest rate of a competitor. Just be aware that some of the low rates available these days are "teaser rates," which only apply during the first 6 to 12 months you have the card.
  • Cancel your old cards so you won't be tempted to use them again. The most you need is two. And leave them at home unless you really need them.
  • Set up a realistic payment timetable and stick with it. If you need to readjust your timetable, do so. If you have trouble, talk to a professional. The counselors at the nonprofit National Foundation for Credit Counseling can develop a more structured plan for you, if needed. To find their nearest location, call 800-388-2227, or log on to

Pay Extra and Save
You can eliminate debt and save money by paying more than the minimum monthly amount on your credit cards. The table below shows the difference between making an assumed $20 minimum payment on a $1,000 debt versus paying $40 a month.
  Total Payments Months to Pay
6% $1,126.97 56
12% $1,353.43 67
18% $1,783.97 89
6% $1,025.24 25
12% $1,103.28 27
18% $1,199.00 29
Assumes a monthly compounding of the annual percentage rate and that the amount due (principal plus accrued interest) must be paid in full.

Put Time on Your Side

You may not be able to solve your debt problem overnight, but you can solve it over time. Not only will a combined debt reduction and saving strategy begin to lighten the load now, it will help you feel better about your future.

Points to Remember

  1. Many people have problems with debt reduction and saving because they don't have a strategy. A good plan can help you channel your funds for the best use possible.
  2. A three-pronged strategy of cash-flow control, saving, and debt reduction can help you begin to lighten the load now and feel more optimistic about your future. Once your debts are paid off, you'll be ready to start investing.
  3. Consolidate your debts using low-interest credit cards. If you don't want to transfer your debts, ask your credit card company to lower your interest rate to match a competitor. Chances are, your company will negotiate.
  4. Set up a payment plan and stick with it. If you need help, talk with a professional.

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