Debt Reduction

Many of us have room in our budget to reduce a few areas of spending in order to increase saving.

Here is a thorough example of how that may work for you:

Debt Reduction Plan

If you are not currently qualifying due to high DTI ratios then you may want

to execute on a debt reduction plan. Here is my suggestion on how to best do that:

Scenario Overview

[should be personalized with your own numbers, the below uses example data]

Annual Income: $75,000 (approx. $6,250 monthly before taxes)

Consumer Debt: $15,000

Residual Income for Debt Reduction: $455 per month

Debt Repayment Goal: Pay off consumer debt as efficiently as possible

STEP 1: ASSESS MONTHL Y

MINIMUM PAYMENTS

First, determine how much of the $15,000 in consumer debt is going to

monthly minimum payments (credit cards, loans, etc.). I’ll assume $300 a

month in minimum payments for this example. This leaves $155 ($455 -

$300) per month that can be put toward reducing the debt faster.

STEP 2: CHOOSE A DEBT

REPAYMENT STRATEGY

There are two primary methods: the debt snowball and debt avalanche.

Debt Snowball: Pay off the smallest debts first, which can build

momentum by quickly eliminating individual debts.

Debt Avalanche: Focus on paying down the debt with the

highest interest rate first, which saves the most on interest over time.

If the goal is to pay off debt quickly and save the most on interest, the debt avalanche method is usually recommended.

Debt Type

Balance

Interest Rate

Monthly Payment

Credit Card $5,000 18% $100

Credit Card $3,000 15% $75

Personal $7,000 10% $125

Total Debt $15,000 $300

STEP 3: EXAMPLE DEBT

REPAYMENT PLAN (DEBT

AVALANCHE)

Assuming $15,000 in total debt with varying interest rates, here’s a sample

breakdown:

A B Loan Using the $455 residual income, apply the additional $155 toward the debt with the highest interest rate (Credit Card A in this example).

1. Credit Card A: Pay $255 ($100 minimum + $155 extra) per

month until it’s paid off.

2. Once Credit Card A is paid off, apply the full $255 payment

toward Credit Card B.

3. After Credit Card B is paid off, apply the entire amount (now

$330) toward the Personal Loan until it’s paid off.

STEP 4: ESTIMATED

TIMELINE AND SAVINGS

1. Credit Card A ($5,000 at 18%):

Approximate payoff time: 22 months with $255 monthly payments.

Estimated interest paid: ~$925.

2. Credit Card B ($3,000 at 15%):

Approximate payoff time: 10 months with $330 monthly payments (after Credit Card A is paid off).

Estimated interest paid: ~$200.

3. Personal Loan ($7,000 at 10%):

Approximate payoff time: 13 months with $455 monthly

payments (after Credit Card B is paid off).

Estimated interest paid: ~$300.

Total Time to Pay Off All Debt: ~45 months (about 3.75 years). Total

Interest Paid: ~$1,425.

Tips to Accelerate Debt Reduction

1. Increase Monthly Payments if Possible: Even an extra $50 a month can cut down on interest and reduce payoff time.

2. Use Windfalls: Apply any bonuses, tax refunds, or unexpected income directly toward the debt.

3. Avoid New Debt: Focus on not accumulating additional debt, which could extend the payoff timeline.

Debt Reduction Plan Summary

This plan, focusing on the debt avalanche method with a monthly $455 payment, will eliminate the $15,000 consumer debt in approximately 45 months with a total interest cost of about $1,425. This approach saves money on interest and allows for the most efficient path to becoming debt-free!

Summary

By reducing debt your credit score will increase and allow you to qualify for a home or a higher priced home if you so choose.

A long-term strategy to keep debt lower than 30% of the total available credit will keep your scores higher but getting out of debt completely and using credit cards for emergency or not at all is a great path forward (but please keep your credit card accounts open with zero balance as that drives your credit scores higher).

Of course, increasing income should also be your continuous strategy, whether asking for a raise, getting a second job, working in ‘gig’ industry or starting a business. Keep the income going up, keeping debt low or no debt at all will bring more opportunity for real estate or other investment strategies to reach your financial and net worth goals.