Step 6 - Paying Off Your Debt

Hopefully by now you are committed to paying off your debt and you have freed up at least a little extra income to help you do it. Now, it's time to start paying it off. The first step is determining which debt to pay off first. Most people are tempted to try to pay off their largest debt first, but this usually isn't the right thing to do.

Get out your list of debts again and see which one has the highest interest rate. If you still have credit cards remaining after the refinance step, it will most likely be them. It is possible that your mortgage or student loans are the highest debt. However, these debts are tax-deductible, so if this is the case and you itemize your tax dedications be sure to keep this in mind. The way to do this is subtract the interest rate times your tax bracket from the interest rate. For example, if you have a loan at 8% interest and you're in the 28% tax bracket, your effective interest rate would be 8 – (8 X .28) or 8 – 2.24 = 5.76% .

If you have more than one debt at the same rate, pay off the smaller one first. Although it makes no actual difference on how soon you will get out of debt or how much you will pay, it will help you see results sooner and encourage you to keep at it.

The next step obviously is to start making the extra payments on this debt. Be sure not to neglect paying at least the minimum on the other debts while you do this, though. Missing a payment can cause you to rack up late payment fees or your interest rate to skyrocket, making repaying your debt even more difficult. As you make extra payments on credit cards and other revolving lines of credit they will typically reduce your minimum monthly payment. Do not lower the amount you are paying! This should be an encouraging sign to you. As your minimum monthly payment goes down, so is the amount of interest you are being charged. By keeping the same monthly payment you are getting the principal paid off much quicker.

It may take a few months or possibly a few years, but if you keep at it you'll eventually get this first debt paid off. This isn't the time to take it easy though, here's what you'll need to do next. First, close the account you just paid off if it's a revolving line of credit, so you won't be tempted to charge it back up. Next, determine which debt has the next highest interest; this will be the next account you pay off. Now, continue to make the same monthly payment you were before, but add to it the money you were paying on the account you just paid off, including the extra payments you were making towards that one. For example say your first debt was for $100 per month and you were paying an extra $50 for $150 total each month, and your second debt costs you $75 per month. You will now be paying $100 + $50 + 75 on this second debt, or $225. That's three times what your monthly payment was before, which will help you to get it paid off much sooner.

Once you get your second debt paid off, repeat this pattern again. Apply the amount you were paying to your first debt, your second debt and your third debt all to your third debt to get it paid off even sooner. As you continue to do this, the debt repayment will rapidly pick up pace. I highly recommend continuing to do this until you are completely debt free, including cars and mortgages, not just credit cards.

If you tried to refinance some of the debt in an earlier step but were unable to get approved for a loan, you may want to look into it again after paying off a few debts. Your debt-to-income ratio is now lower and you have built up a good history of paying off your debt, both of which will help your credit score and make it possible to get approved for loans you weren't able to before. However, be sure to also re-evaluate if it's still in your best interest to refinance, now that your debt has been reduced and you are making higher payments.

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