5 steps to help tackle debt

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Most people have to tackle debt at some point. Laying out a clear, coherent plan — and sticking to it — can help you get back on the path to your financial goals.
Borrowing money is a part of life. For most people, borrowing has its place, particularly when they're buying big-ticket items such as a car or a home. It can even offer tax benefits, since some interest payments are potentially tax deductible. Still, it's easy to take on too much debt, which can undermine financial stability. No wonder, then, that many people look for ways to pare down their debt, especially as they approach retirement.
As a rule of thumb, "total debt service, which is all of your annual debt payments — including your mortgage, student loans, credit card and personal loans — divided by your gross income should be no more than 36%," says Nevenka Vrdoljak, director, Investment Analytics, Merrill Lynch. The money you spend on monthly interest charges, not to mention nagging worries about falling behind on your payments, can threaten your long-term financial goals and your peace of mind. If you want to reduce your debt, you need a strategy that suits your personal circumstances.
"It's important to understand what money is coming in and where it's going out," says Michael Troicki, director, Financial Center Sales and Merrill Edge. "That way you can divert money from where it isn't needed to pay down debt." It's also key to have an understanding of why you needed to borrow money in the first place and how borrowing works within your overall financial life. To help accomplish this, you might:
Step 1: List all your debts. First, gather and document how much you owe, the interest rate you pay on each loan or credit card, and how much money you currently devote to debt reduction each month.
Step 2: Define your debt goals. Do you want to reduce your debt to a particular level or be completely debt-free? What is your timeline? With these questions answered, calculate how much you need to pay each month to meet those goals. Then look at ways to find the money you'll need — such as cutting expenses, getting a part-time job or turning a hobby into extra income.
Step 3: Consider consolidating or refinancing. Explore opportunities to consolidate your debt, perhaps by taking out a home equity loan or a low-rate credit card. This could significantly reduce your overall monthly interest charges and make it easier to pay off the principal. Just be sure to read the fine print. Some offers include high fees or interest rates that balloon after an initial "teaser" period.
Also, with interest rates being low, it may make sense to consider refinancing your mortgage. If you plan to stay in your home long enough to cover any refinancing costs, you may be able to reduce your monthly payment or keep your payments the same, but pay off your mortgage sooner.
Step 4: Begin paying down your debt. You might want to focus on paying the highest-interest debt first, since this is the biggest financial drain. Another way, often referred to as the snowball method, focuses on paying off the debt with the smallest balance first, while making minimum payments, or more if possible, on your other debts. Once that smallest debt is paid, continue to tackle the debt with the next lowest balance. Any extra funds are then paid to the highest-interest debt. This strategy can help you make some quick progress, giving you the momentum and encouragement you need to stay on track with your plan.
Step 5: Plan for your next financial goal. Once you've accomplished your debt-reduction goal or are well on your way, you can take steps to help keep your level of debt manageable. Compare your spending with your income to make sure it's sustainable. Also create a rainy-day fund with six months' worth of expenses, to reduce the chances of having to take on new debt in the future if your financial situation changes for the worse. Saving even a small amount can make a difference.
Most people have to tackle debt at some point. Laying out a clear, coherent plan — and sticking to it — can help you get back on the path to your financial goals.
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