Many people in debt make their credit card payments every month but feel as though they aren't making any progress toward paying off their balances. In order to get out of that threatening cycle, debtors need to create a financial plan that will effectively reduce their debt.
What Is Debt Reduction?
Debt reduction is the process by which a person in debt manages their balances and continues to make payments. Through debt reduction, a debtor can clear themselves of pesky creditors and collectors. To do so, the debtor must make some sort of financial plan, of which there are many, and stick to it over time. Often slowly, the debtor finds their way out of deepening debt.
How Debt Reduction Works
Debt reduction is based completely on the debtor's actions. In order to reduce debt, a person must acknowledge their existing balances and take steps to manage them. There are several different methods to debt reduction, and a few of them are as follows:
- Debt-snowball method: The debt-snowball method of debt reduction is a debt management technique most commonly applied to repaying revolving credit. In it, debtor's aim at repaying their smallest balances first, and slowly building upward. To do so, the debtor first lists all their existing balances, in ascending order, and commits to pay the minimum monthly payment on every debt. Any extra spending money afterward is put toward the smallest balance. When the smallest balance is paid off, its old minimum payment is added to the minimum payment on the next smallest debt. That amount, plus any extra income available is put toward that next smallest debt. This is repeated until all debts are paid off.
- Debt settlement: Also known as debt negotiation, debt settlement is a situation in which a debtor and creditor agree on a reduced balance that will be regarded as payment in full. While a debtor may do this themselves, some hire a lawyer to act for them, or use a debt settlement company. Debt settlement is only possible for unsecured debts like medical bills and credit card balances. Secured loans on assets like cars, homes and student loans are not eligible for debt settlement.
- Debt management plan (DMP): DMPs are typically for debtors who are struggling more than the typical credit holder. For example, many DMP participants have credit payments that exceed their income. A DMP takes place when a third-party organization meets with creditors to negotiate a reasonable repayment plan for the debtor, taking into consideration their available funds after priority expenses are handled, such as mortgages, rent and food.
- Debt consolidation: Usually the last resort before filing for bankruptcy, debt consolidation involves the debtor taking out a loan that will pay off all their other loans. In essence, it lumps all the debtor's balances into one lump sum, often lowering monthly payments and decreasing interest rates. Debt consolidation gives the debtor more time to pay off a large balance without handling multiple payments at once. While debt consolidation temporarily reduces debt, it can heighten it in the long-run, as longer periods of payment lead to more interest and higher balances.
In the end, there is more than one way to reduce debt. Other financial experts will say to pay off the cards with the highest interest rates first, thereby avoiding any additional balances accruing due to interest alone.
So It's Time for Debt Reduction
The first step in reducing debt is realizing how much of it you have. Before moving forward, gather all your recent statements and documents regarding your debt. Go over the amounts, and make a list of what you owe, who you owe to, and how much you can afford to pay on your debt each month. If your minimum monthly payments are higher than your income allows, then you will need to consider some sort of debt settlement or other professional consultation. Always, before you sign any kind of contract or make any sort of down payment for financial services, check the financial institute's credentials, customer reviews and company affiliations. Red flags include creditor affiliations, several reviews regarding scams and credentials from companies you cannot find online or in the local library reference section.