Tame the debt monster

In December and January, The Simple Dollar is posting a daily series focusing on specific activities you can do right now to set the stage for a great 2011. Out with the old, in with the new.

5. Clean up your debts.

No, I don’t mean just repay them. For most people in debt, saying “pay off your debts” is pretty trite. It’s an action that they can’t afford or else they wouldn’t have debts to begin with.

Instead, a better first step to take is to clean them up. Minimize interest rates. Lower monthly payments. Refinance. Negotiate. Consolidate.

Here are several steps you can take to clean up your debts which will both reduce your monthly payments as well as the interest you owe on the debts without wrecking your credit rating.

Refinance your mortgage Interest rates on home mortgages are ridiculously low right now, often dipping below 4%. If you are not underwater on your home and you have an interest rate that’s above 5% and you still have more than a few years to go on your mortgage, it’s almost assuredly worth your while to refinance.

If you have other collateralized debt (usually a car loan) that’s at a higher rate than your refinanced mortgage, you should consider pulling that debt into your mortgage by borrowing enough to pay off the automobile. Do not use your refinance to pay off non-collateralized debt, though – don’t put your home at risk just to pay off credit cards.

I usually recommend starting with your local credit union or with your current lender when considering refinancing, but don’t be afraid to shop around.

Lower your credit card interest rates I wrote a detailed guide for this a while back and the general information there still holds true. You should give this a shot if you have a substantial amount of debt sitting on credit cards and have largely been able to make your payments up to this point and it’s not going to cause a financial apocalypse for you if you have a card cancelled or a credit limit reduced along the way. If you’re teetering on that kind of edge, be careful.

The process is simple – just call the number on the back of the card, state that you’re considering switching your active use to another card because of the oppressive rates, and ask for a rate reduction. If the first person won’t do it, ask to speak to their supervisor.

While you’re there, ask about any balance transfer offers that they have available on your card, in preparation for the next tip…

Consolidate your credit card debt through balance transfers If such transfers are available to you, transfer the debt from your highest interest rate card (after getting all the reductions you can) to your lowest interest rate card. This will not only help with the monthly payments, but will also help with the overall interest you have to pay. You can also do this via a cash advance.

Make sure you understand, however, that different balance transfer offers handle transferred balances differently. Some charge a different rate on balance transfers, so if you’re considering a transfer, ask for the details before you leap in.

Cancel unused cards besides your oldest Your oldest card should remain because it establishes the length of your credit history. Aside from that, unused credit cards mostly just provide a route to identity theft – something you don’t need.

I usually advise people to cancel cards with a zero balance that are not their oldest card or their most frequently used card. This way, you minimize the options for identity theft and have fewer things to worry about in the event of a stolen wallet and so on.

Now that you’ve trimmed the tree a bit, how do we go about knocking it down? We’ll talk about that tomorrow.

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