The Good, The Bad and the Payoff Plan

Managing your debt is an important skill, and the better you understand your financial situation, the more likely it is you'll be able to stay on top of it, rather than letting it take control of you.

Do you have unpaid balances on your credit cards? If so, you're not alone. In fact, millions of Americans are burdened with this type of consumer debt. And while not all consumer debt is bad, you need to be able to manage it properly. And if your debt has already gotten out of hand, you need to know how to take control again.

Analyze Your Debt
Do you feel overwhelmed every time you sit down to pay bills? Join the club! But what you need to remember is that not all debt is bad debt. For instance, home loans or education loans are viewed more as more favorable debts than say, credit card debt. They represent an investment in your future. So really, a mortgage or student loan is viewed as good debt. On the other hand, credit card debt is bad debt. Why? Because you haven't invested in anything. Credit cards are generally used for things like clothing, food and entertainment - things that won't appreciate in value. Some people use a credit card for all of their purchases - for the sake of convenience - and then pay off the balance in full each month. If you can trust yourself to pay the credit card off every month, it's not necessarily a bad thing. However, if you consistently can't pay the balance each month, and in fact continue to charge new items, you may have a debt management problem.

Even if your consumer debt is the good kind, you still must be careful not to overextend yourself to the point where you can't keep up on payments, which can hurt you as much as carrying bad debt can.

Once you've analyzed your debt situation, it may be time to formulate a plan to pay off your debt - especially if your bad debt outweighs your good debt. If you're in this boat, you best bet is too pay off your bad debt first, including credit cards and even car loans. You may be tempted to use your good credit (2nd mortgage, home equity loan, etc.,) to pay off bad debt, but it's not wise for a number of reasons. First, it will take you longer to pay off your home. Second, you should avoid paying off debt with more debt. Third, your mortgage payment will increase, so you won't really be saving much money each month. The smartest thing you can do is to pay off debt with cash.

Make a Payoff Plan
If your analysis has shown that you're loaded down with bad debt, you need to take action immediately and form a payoff plan. To start with, list all of your creditors with the amounts due and the monthly payments. It's much easier to have this information in black and white, and all in one place, rather than just abstractly thinking about it once in awhile. Next, determine how much disposable income you have each month. Disposable income is the amount of money you have left over after paying all of your bills, buying groceries and filling your gas tank. From this amount, decide how much extra you can pay toward one of your debts.

There are two schools of thought on which debt you should pay off first. Some people advise paying off the debt with the highest interest rate first. This makes sense because it will save you money in the long run. Others advocate paying off the debt with the smallest balance first. This is effective for keeping you motivated, since you'll reach the goal of payoff faster. Choose whichever method you think will work for you, and then add the extra amount you determined to the regular monthly payment. Once your first debt is paid off using this method, devote the amount you were paying on it each month to the next debt on your list and so on until you get them all paid off. It does take time and patience, but if you're consistent, it will work. In fact, once you've paid off all of your bad debt, you can even use this 'snowball' method to pay off your good debts!

Managing your consumer debt is an important skill that deserves your time and attention, both to stay on top of your finances and to work your way out of debt.