Your mailbox is full of bills and you’re starting to receive phone calls from debt collectors. You know that you need to get your financial house in order, but it seems like you never have enough money to make it through the month, let alone pay down your debts. Digging yourself out of debt may seem impossible, but it can be done. Here is what you need to do to prioritize your bills and get yourself debt-free:
Sit down with all of the bills at once.
In some ways, this is the most difficult step. Seeing all the numbers in black and white can feel overwhelming. But recording your monthly outflow—including due dates, fees and interest rates—is necessary before you figure out how to tackle the payments.
Make a budget.
Once you know how much you owe each month and when, you can figure out how much of your income is needed to pay your bills. If you do not make enough money to cover all of your monthly bills, then you need to start prioritizing what you pay. At the top of the list should be the bare necessities: mortgage or rent, utilities, food, and transportation. With these things in place, you know that you can safely keep a roof over your head and continue working. Any money left over after these necessities are met should go to your other debts.
After you have covered what you need, it’s tough to know which debts to work on next. While not paying some debts can lead to serious consequences, others offer you some leeway. It’s also important to know your rights.
If you are already being hounded by debt collectors, know that you have rights under the Fair Debt Collection Practices Act (FDCPA). You do not have to put up with harassing behavior, contact at your place of work, or abusive language.
Here are the debts you must pay, in order from the most to least important, as well as a breakdown of what you can expect from each one:
1. Child support. Since these payments are mandated by the courts, failure to pay child support can land you in jail. If you are having difficulty paying child support, you can petition the court to modify your payment. However, that process can take some time and you are not guaranteed a modification.
2. Taxes. Non-payment of property or income tax can lead to the government seizing your home and/or garnishing your wages. Don’t let it come to that. If one of your debts is to the IRS, call them and find out if you can negotiate your payment. While the IRS will not forgive your debt, you can generally work with them to find a solution that will work for you.
3. Student Loans. While student loan debt offers you a great deal of leeway, it’s important to remember that the government can try to collect on defaulted loans in ways that are not available to typical collections agencies. For example, the federal government can take any income tax refunds you receive until the debt is paid, garnish your wages, and potentially take federal benefits like Social Security retirement.
If you are having trouble paying your bills, call and ask to have your student loan put on deferment. It will give you breathing room and keep your tax refund safe.
4. Credit Card bills. Paying the minimum on these will keep creditors at bay, but it will also keep you in debt for a long time. However, these bills should be lower priority than those that keep a roof over your head. Also, though credit cards do not advertise this, they will work with card-holders who are having trouble paying. They would rather you call and explain your situation and ask for a temporary change in your minimum payment, or even a short deferment, than have you simply not pay them.
5. Medical bills. The medical community recognizes the high cost of health care and most hospitals have a financial office that will work with you. For example, my son had to have a minor procedure at a children’s hospital when he was 7 months old. Our insurance covered 90% of the $7000 procedure, but we still had to pay $700. The hospital is allowing us to pay $50 per month without interest for up to 18 months, which will give us more than enough time to pay off the debt.
If you have high medical bills, talk to the hospital about how to make payments over time.
Even if you know which bills to pay first in terms of potential consequences, it can still be confusing to know what to pay and when. There are two major strategies for debt payoff: Dave Ramsey’s Debt Snowball, and Suze Orman’s Highest Rate First strategy.
The Debt Snowball
This approach might not be the best mathematically, but it offers a great psychological boost to anyone who needs to know they are making progress. Ramsey suggests that you pay the minimum on all of your debts except for whichever one has the lowest balance. Send however much you can to that low balance debt until it is paid off. Then, send that same amount, plus the minimum you were already paying, to the next lowest balance debt. When that is paid off, send the combined amount from the first two to the next lowest, and so on.
The benefit of this approach is that it allows you to see your progress. Each month, you are still sending the same amount of money to all of your bills, but you are seeing them killed off one by one.
Since you are paying in order of low-to-high balance, rather than paying based on how high your interest is, you may find that you end up spending more overall, however. This is why Suze Orman suggests you use her strategy.
Highest Rate First Strategy
In this case, you list your bills in descending order of interest rates. You will send the minimum amount to everything but the highest rate, and send whatever extra you can to that one. By doing this, you will minimize the interest you will pay over the life of the loans. Once you’ve paid off your highest interest rate debt, move on the next, and then the next.
While this approach makes more sense mathematically, it can get a little discouraging to feel as though progress is very slow. Finding a way to track your progress—like with a debt payoff thermometer that you post in your home—can help to make this strategy feel more exciting.
The Bottom Line
The main thing to remember when prioritizing your debts is that any strategy is better than none. Be proactive by contacting your lenders, and find ways to motivate yourself to pay down your debts. Your consistency will pay off.
Photo credit: Alan Cleaver