Keeping Your Resolutions: Paying Down Debt

During this first full week of the brand new year, I thought I would turn my attention to helping my readers keep their New Year’s Resolutions.  We all make them, and all too many of us abandon them before we make much progress.  I’ve put up several of my resolutions last week, as well as how I intend to accomplish them.  I thought I would provide some advice and encouragement to my readers when it comes to their personal finance goals.  (Sorry to anyone who resolved to lose weight, exercise more, or find love; those sorts of resolutions are outside the purview of The Amateur Financier.  Good luck, though.)

In order for your resolutions to be good and helpful to you as goals for the new year, they need to be actionable, specific and reasonable.  In order to be actionable, you need to make your resolution dependent on things that are in your power to control.  Saving more of your money is in your control, winning the lottery is not; thus, saving more is a decent resolution (although, we’ll improve on it in just a minute), while resolving to win the lottery to pay off your debts is not.  A specific resolution will provide you with a particular goal, one you can judge your progress towards through out the year and determine whether you are making adequate progress.  So, resolving to save $100 per month is a much better goal than simply resolving to save more; you can monitor how much you save and see if you are meeting your $100 a month goal, falling short, or (hopefully) exceeding it.  Finally, your goal has to be reasonable; we all have limited resources of time, energy, and money, and we need to prioritize how we expend them in order to achieve everything we hope to achieve.  What’s reasonable will depend on your circumstances; if you net $1000 per month after taxes, saving $100 each month is perfectly reasonable; if you are only making $200 in net income, saving $100 is too much of a stretch, and a more reasonable goal might be $20 or $25 each month.

So, now you see how we can apply these techniques to a goal of building up your net worth; how do we apply them to paying down debt?  (Be it credit card debt, student loan debt, or some other type of debt we find ourselves facing.)  Let’s see how we can apply these three principles to paying down your debt:

Actionable: ‘Becoming Debt-Free’ has a nice ring to it, doesn’t it?  Unfortunately, it’s not really that actionable; it tells us nothing about how you’re going to become debt-free, or what actions you’ll take along the way.  Something more along the lines of ‘Pay down the amount of debt I owe each month’ is a much more workable resolution.  But we still need to make it specific…

Specific: Now that we have a particular plan of action in mind, it is time to make it specific.  Paying down the amount of debt you owe each month is good, but you should set a goal for how much you’re going to spend on debt reduction.  You can either specify this in terms of how much you want to reduce the total amount that you owe (‘I’m going to pay down my debt by $50 each month’) or the total amount you intend to spend on debt service (‘I’m going to spend a total of $200 each month on debt service’).  The former method has the advantage of telling you how much your outstanding debt will decrease each month, but you’ll need to budget for interest and other fees separately to meet your goal (so you’ll end up spending more, possibly much more, than $50 each month).  The latter method gives the total you intend to pay each month, making budgeting easier, but doesn’t indicate how much your outstanding debt will decrease (and it will be a different amount each month, as you pay down your debt and more of the money goes to the principal, rather than fees and interest).  Either method works, so choose whichever seems easier and more motivational to you.

Reasonable: It’s a bit tough to define just what constitutes a reasonable debt repayment plan, as so many factors will influence your personal financial situation and ability to pay down your debt.  A good rule of thumb would be to commit at least 10-20% of your net income (after taxes and matched retirement contributions) to debt servicing, including interest, fees, and paying down the balance.  If you use the second method I discussed above, it’s fairly easy to look at your net income, calculate ten percent, and pay that much toward your debt each month (assuming it is enough to cover the interest with some money still going to the principal; otherwise you’ll have to increase the amount you pay).  Make sure that this amount is both sufficient to cut down your debt while not stressing your budget too much (cutting back to repay debt isn’t bad, trying to live on Ramen to pay down all your debt this year isn’t).  For the first method, you’ll have to have a feel for what you pay in interest and other fees, and be sure to add your desired principal repayment amount on top of that.  Again, be reasonable about what is possible for your family and your budget; better a slower, less stressful debt repayment schedule than one that drives you completely insane.

That’s all there is to it; create your plan, keep to it each month, and monitor your progress, and soon you’ll be debt free!  Good luck!

P.S. Feel free to check out my Ten Commandments of Credit Cards for more advice on using credit properly and getting yourself debt free if you wind up in credit card debt.

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