Big Steps to Paying Down Your Debt

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Consumer-spending strength has a plastic backbone.

Through the month of July, consumers were saddled with a record $1.72 trillion in debt, an increase of $500 billion in five years, according the most recent data available from the Federal Reserve. As of 2002, the average American family had close to $7,000 in credit card debt -- that's excluding health-care costs, car loans and mortgage payments.

Along with record debt levels have come record numbers of bankruptcy filings -- with 1.5 million cases filed in the last 12 months and 400,000 cases in the second quarter alone, according to information from the Administrative Office of the U.S. Courts.

The economy is teetering between double dip and slow growth, and neither benefits the serial debtors among us. If it worsens, unemployment will rise -- meaning it gets harder to service that debt. If it brightens, interest rates will rise -- meaning it gets harder to service that debt.

Now is the time to get your house in order. Here are the 5 1/2 steps you must take.

1. Read the Signs

Just because you have a Fair Isaac credit rating above 700 and get bombarded with 0% annual percentage rate card offers doesn't mean you're immune from debt problems.

There are the basic signs that you're in trouble: carrying a balance on more than three credit cards -- yes, the Home Depot card counts; making only the minimum monthly payments; and using cash advances to pay bills. But most experts say people don't reach that point until they're hit by an unexpected crisis.

"Chances are you're living paycheck to paycheck," said Howard Dvorkin, president of Consolidated Credit Counseling Services, who adds that a quick back-of-the-envelope calculation can determine if you're on the road to ruin. "Somebody who has a 15% debt-to-income ratio has a problem; that means they spend 15% of their take-home pay servicing debt."

2. Check Your Balance Sheets

OK, if you're one of those people above the 15% level, you have to do a hard assessment of your financial situation.

Fudging your household accounting can burn you the same way it burned big business, especially when you have an overinflated view of how much you really make, or an loose sense of how much you spend. Sit down and figure out your income and expenses.

"If you ask people how much money they owe, I guarantee you most people will not have a clue," said Dvorkin. "Do a budget of everything you make and everything you spend. And if that comes out negative, you're in trouble."

Thankfully, doing a budget and sticking to it can be easier than ever, thanks to the Internet. A myriad of sites, like debtfree.org, have guides that can walk you through the process or even do it for you. Once that's done, it's time to take the battle to your creditors.

3. Lower Those Bills

Now that you see how much you spend, look for ways to spend less. In this economy, companies need your money and they're willing to barter to keep you as a customer. Whether it's a phone provider, a credit-card company or an auto insurer, most people don't shop around -- and if you don't, you're losing money that could be put to paying down your debt.

"It's not unusual for me to see people who make six figures paying $3 a minute for long distance because they never checked," said Steve Rhode, president of Myvesta.org, an online financial-crisis center. "But of all the things, the worst one is cell-phone bills. You need a PhD to figure out those pricing plans."

This is where the Web can give you an advantage. A variety of comparison shopping sites, like LowerMyBills.com, allow you to compare multiple offers simultaneously to see if you're getting the best deal.

If you're not, Rhode recommends you call up your creditors or service providers and demand a lower rate or better terms. More often than not, you'll be successful -- customer-service reps are authorized to make a deal right there on the phone.

With interest rates as low as they are, refinancing the mortgage -- the biggest debt burden for most Americans -- is a great way to shave a few hundred dollars off your monthly expenses.

4. Put Those Savings to Use

Take every penny that you saved -- the refinanced mortgage, the lower credit-card rate, the flat-rate cell phone, etc. -- and start mailing off the checks to your creditors.

Yes, of course. But what's the most logical way to pay down the debt? Some would counsel you should consolidate your bills and make a single payment each month, but many debt-consolidation plans are laden with huge fees that end up hurting more than helping.

The better route is to whip through your monthly statements and pay off the cards that carry the highest rates. Some retailers' credit cards -- the one you got to get that 10% one-time discount on $250 worth of clothes, remember? -- cost an arm and a leg to finance, north of 20% in many cases. Wipe the heavies out first, then make your way down the line.

It may also make sense to pay off those pesky $300 and $400 balances upfront. "Especially at the beginning, it can a psychological boost -- a sign you can get something done," said Rob Herrick, supervisor of client services at American Consumer Credit Counseling. Once you do, if you don't need those cards, cancel them. Your burden will be lighter.

5. Avoid Temptations

Those tempting offers were what got you in trouble to begin with; don't count on the banks or car companies to save you from yourself. They've been courting you with 0% financing deals to keep their business puttering along, and lending standards have grown lax. "Just because you're approved for a 0% card doesn't mean you should use it," said Rhode.

Most times, the 0% financing deals offered come with time limits and all kinds of strings attached. While it may seem perfectly affordable now, that 0% rate on the $1,300 refrigerator you bought will jump into the double-digits after a year.

Bottom line on temptations: Think long and hard about every big-ticket, non-essential purchase you make. Sleep on it. If you really need that Sega Genesis, reward yourself with it after you've cleared another credit-card bill.

5 1/2. Have Someone Else Do It

This one's not for everybody -- hence the fractional appendage. It's aimed at those serial debtors who manage to run up their credit cards within a few months of, say, taking cash out of your mortgage refinancing to pay it off. For those addicted to debt, do-it-yourself articles about getting your debt levels are of little use. That's where professionals come in.

While it may seem counterintuitive to pay to get out of debt, debt-counseling services can give you direction and focus for a relatively cheap price. Most have a $40 enrollment fee and small monthly charges. Just remember to pick a not-for-profit debt counselor that has been accredited or approved by the Better Business Bureau.

Those with deeper pockets and less free time can go the "lazy man's lobster" approach and pay more to have a service, like Myvesta's "All Paid" program, do everything -- including pay bills -- for them. Costs are extremely high, running $75 an hour, but for hard-core spenders, kicking the debt habit can't be kicked without serious professional treatment.

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