Magnifying glass with the word debt

Strategies to Tackling Debt

Whether you’re dealing with personal or business debt, unmanaged debt can lead to serious consequences for your personal and business life.  From the mental stress of dealing with creditors to the reduced cash flow from interest payments, taking care of your debt is critical to your financial and emotional well-being. 

One of the key things to remember about getting your debt under control is to focus on the process of managing your debt.  If you are consistently doing all the right things, your credit card debt will fall.  Follow these strategies and you’ll begin to feel the financial and mental freedom of lowering your debt.

1.     Stop Digging

What’s the first step in getting out of a hole?  Stop digging.  You need to reflect and evaluate how you acquired so much debt in the first place.  The answer is the same for everyone: your spending exceeded your available cash.  You may have had good reason to spend more money than you had.  Medial bills, tuition, expanding your business; all these are valid reasons to temporarily spend more money than you have.  But now it’s time to cut back on spending.  Take a hard look at your expenses and decide what can be reduced (good) or eliminated (great).  For instance, maybe client entertainment should be used more sparingly. 

2.     Put the Cards Away

Take those credit cards and put them in a safe place that is not your wallet or purse.  You are more likely to spend more money with a credit card than you are with a debit card or when you need to write a check.  A note about those cards; don’t run off and cancel them just yet.  Cancelling a bunch of credit accounts can actually damage your credit score.  Just put the cards out of sight and out of mind.

3.     How Much do you Owe, Exactly?

Before you move on to other strategies, take stock of your total debt.  It may sound funny, but many Americans don’t know exactly how much they owe.  For some, ignorance is bliss.  While for others, they just haven’t taken the time to sit down and look at their total debt.  Create a simple spreadsheet with Creditor and balance.  It could look something like this:

Simple creditor balance table

4.     Target Highest Rates First

Some financial “experts” tell you to pay your lowest balance off first, despite the debt’s interest rate.  While this may be a psychologically rewarding feeling, mathematically it may not make sense.  You always want to pay off the debt with the highest rate first.  This will pay your debt off the fastest – and getting out of debt as fast as possible is the ultimate goal.  So, add the interest rate to your spreadsheet and kill the highest one first:

Creditor balance table with interest rates

A note about interest rates and taxes: You always want to consider the AFTER-TAX interest rate.  If you are deducting your mortgage interest and the deduction is saving you 20% on income tax, a 3.75% mortgage rate is effectively 3.0%.  If you’re a business, almost all your interest is tax deductible, so you want to calculate the after-tax cost of your debt.  The formula to calculate your after-tax cost of debt is:

After-Tax Interest Rate = Interest Rate x (1-tax rate)

5.     Create a Realistic Budget

Apart from knowing how much you owe, create a plan of action that indicates how you are going to spend less than you bring in.  There are plenty of budgeting apps and tools, like Mint for individuals or QuickBooks for businesses.  Creating a budget is a great first step, but most of the value in budgeting will come from comparing your budget each month with the actual expenses incurred.  Look at the variances per line item.  Why are you spending more than you budgeted and how do you reduce those expenditures to budget levels in the future? 

6.     Setup a Separate Emergency Fund

One reason people and businesses take on debt is because they don’t have enough cash for emergencies or critical expenditures.  As you begin paying down your debt, also begin building up an emergency fund.  These funds could be in a separate checking or savings account, or in a relatively safe investment account.  What’s the right level for this account?  Well, we know it’s more than zero, so begin funding now.  Most businesses should have 60 days of critical spending reserves.  Critical spending would include those expenses you absolutely need to pay to keep your business going.  Payroll, rent, utilities, taxes, these are a few examples of critical spending.

7.     Sell Stuff

Whether you are a business with some outdated inventory or an individual with some old furniture, take stock of those assets you have lying around that have no/little value to you, but might have value to someone else.  Many businesses can find significant cash in scrap and outdated inventory. 

Conclusion

Debt can crush a business and bankrupt families.  It’s important to get control of your situation and deal with your finances.  By focusing on making the right decisions, any debtor can get control of their finances and reduce or eliminate their debt.

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