Why Debt Reduction is Important
Make Reducing Debt your Top Priority When Getting your Finances in Check.
The amount of debt you carry may seem manageable, and if so, you may not see any immediate need to reduce it. Nonetheless, debt reduction can always be a valuable tool. Even if you are able to pay your bills on a timely basis, carrying a high debt load can be dangerous, for several reasons. First of all, situations change. You may have to take off work, get laid off, or have an unexpected financial burden, and if you have a high debt load, that extra expense or reduced income may be just enough to put you over the top of your ability to pay.
There’s a big difference between being able to pay your bills but having nothing left, and paying your bills and having a cushion. You should be able to pay your bills on a timely basis and still have enough left to bank some cash away for a rainy day as well every week.
In addition, having a high debt load may prevent you from getting any additional credit, even if you are paying your bills on time. When applying for credit, the credit issuer looks at a lot of factors beyond whether or not you pay your bills on time, they also look at the ratio of how much debt you have to how much income you have.
As a result, even if your credit report doesn’t show any late payments, if you have a high level of debt, chances are you will be either denied credit entirely, or if you do get credit, any additional credit you get will be at a higher interest rate, because the issuer will see you as a greater risk because of your debt load. And when you start taking on additional debt at progressively higher interest rates, you’re entering into a slippery slope to disaster.
Reducing your debt has two benefits then: first, it allows you to have more of a weekly cushion, because you have more money left over after you pay your bills. Second, it allows you to take on debt when you need to at a more attractive rate of interest. Achieving debt reduction is first just a matter of diligence—pay your bills on time, pay greater than the minimum due, and avoid excesses in your personal spending habits. However, just as it is possible to be an excessive spender, it is also possible to be an excessive payer.
Yes, you can pay “too much” on your debts every month as well as too little. Some may be tempted to pay down debt by simply putting every available penny towards bills. This strategy may have the desired effect of reducing your credit card bills and other debts, but it will also have an undesirable effect: No savings. The trick is to achieve a balance by paying the debt down on a regular basis over and above the minimum payments, but at the same time, putting aside a fixed amount every week in savings so that should an emergency occur, you can continue making your payments as needed even if you suffer an extra expense.
Besides the obvious strategy of just spending less, there are other ways to reduce debt even with the same spending level. Debt shifting may be just as good as debt paying, if you are shifting debt from a higher interest rate to a lower one. Suppose you have a credit card that carries an 18 percent interest rate. You apply for and receive a credit card that carries a 12 percent rate, and gives you the bonus of zero percent interest for six months on balance transfers.
By transferring the balance of the higher interest rate card to the lower interest rate one, you get the immediate benefit of zero percent interest for the introductory period, plus a lower interest rate thereafter. As a result, even if you are paying the same amount on the debt, you will pay the debt faster. Beware however, of credit cards with high annual fees. The annual fee may well wipe out any savings you get from a lower interest rate.
Additional resources:
Credit: Consumer Information from the FTCFool’s Rules of Credit Management
Tips for Reducing Credit Card Debt
The Wachovia Guide to Reducing Debt
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