Your Path to Freedom from Debt in 2012

John Vaughan (Financial Advisor) @ Lucid Living

The beginning of a new year offers the chance for a fresh start with your budget and financial strategy. For those in debt, it should mean the opportunity to commit yourself to saving money and reducing what you owe.

To help, Adv Randolph Samuel, CEO of the Credit Foundation of South Africa, has outlined some advice to assist with both of these goals so you can pay off debt once and for all.

Step 1: Saving Money to Pay Off Debt

Chances are that over 2011, your budget increased or your financial discipline slackened. Use the new year to revisit your budget and find even more money to save.

First, trim back those expenditures that might have risen. Then identify opportunities to save even more money based on changes in your life. Switched gyms? Make sure to eliminate recurring charges that you forgot to cancel. Stopped reading your magazine subscriptions? Remove automatic renewal from your credit card.

You can also find a number of small savings opportunities within a monthly budget that can add up over time. For example, eliminating an extra R100 a week between cuppacinos or lottery tickets can total an extra R5000 in savings for 2012.

Step 2: Reducing Debt You Currently Have

With that extra money in hand, now is the time to remain disciplined and begin reducing debt. By allowing your credit cards to continue accruing interest, you are only lining the pockets of the banks.

Take your extra monthly savings and apply it to your outstanding credit card principle debt. It will help reduce the interest you owe and give you a shorter horizon to freedom from debt. Do not rely on minimum payments to get rid of credit card debt–they reset every month as a percentage of your balance and can trap you in debt for years to come.

In addition, there are a number of possible options for reducing debt. Each has its own unique advantages and dangers. They include:

Optimized Self-Payment

Many households with a small amount of debt can eliminate it through better budgeting or customized self-payment schedules dubbed “avalanche” or “snowball” to more quickly eliminate debt, interest and your overall balance.

If you have some flexibility within your monthly budget or have cash resources on hand, this is the best option to consider because it does not impact your credit score or expose you in any way to creditors.

Debt Consolidation

Those families that hold high credit card debt with little cash reserves, but do have a good credit score and own a home with a significant amount of equity, might consider debt consolidation. With mortgage rates still at all-time lows, this is a good time to secure a consolidation loan if you qualify.

In this transaction, you would borrow enough money to refinance your home and pay off debt at the same time. This consolidates higher credit lines into your home loan and a single payment with a lower interest rate.

The danger is that you are moving unsecured credit card debt into a secured home loan, meaning you are placing your house as collateral in the event you default. Families should carefully examine the loan payment schedule and their financial situation to ensure they can meet payment obligations on the new loan.

Credit Counseling

Credit counseling companies negotiate reductions of penalties and interest charges on debt, but leave the actual principal balance intact.

This offers a reduced time to payment and lowered monthly payments with minimal impact to your credit score. In fact, credit counselling companies often negotiate the clearing of blacklisting, as a condition of the agreed repayment – resulting in an improvement of your credit score. This results in a reduction in the overall amount you owe.

Debt Counselling

Debt counselling is an aggressive course of action in which you make substantially lower payments to creditors while a settlement is negotiated on your behalf.

This can dramatically reduce the amount you owe creditors while also resolving your debt quickly. However, it will lower your credit score and can subject you to debt collection efforts and even legal action.