Credit Basics

April 15, 2006

Expert instructions for paying your dues

1. Examine your habits.

“Most people think the first thing they need to do is set a budget,” says Deborah McNaughton, the founder and president of Professional Credit Counselors and the author of The Get Out of Debt Kit: Your Guide to Total Financial Freedom (Kaplan, $19). “But they can’t set a budget until they know how much they’re spending.” To that end, she recommends first taking a month to keep a journal in which you keep track of every purchase — including rent, food, clothing, gas, bills, lattes — right down to the last penny. Once you see what your spending habits are, you’ll see where you can cut back.

When you sit down to determine your new budget, be sure to count everything. “People forget what I call ‘budget busters,’” McNaughton cautions, “like insurance, car repairs, taxes — things that are not a monthly expense.” To avoid the inevitable end-of-year scrambling that happens if you forget to consider these items, she recommends figuring out how much you spend on, say, taxes for the whole year, then dividing that by 12. Then each month, save a piece of what you’ll need at the end of the year.

2. Examine your debt.

Next, it’s time to figure out what you owe. “Get all your bills together for one month, sit down at the kitchen table, and analyze them one by one,” says Howard S. Dvorkin, the founder of Consolidated Credit Counseling Services (www.consolidatedcredit.org) and the author of Credit Hell: How to Dig Out of Debt (John Wiley & Sons, $20). “Essentially, [that means] listing every debt you have, how much you owe, how much your minimum payment is, how much your interest is, and what the balance is.”

3. Determine your options for tackling the debt.

Is borrowing money from family a possibility? Should you refinance your house? Can you consolidate your credit-card bills? These are just some of the questions to ask when determining the best way to solve your debt problems. Making matters even more complicated is the fact that no two debt situations are alike. “Refinancing the mortgage may be a good bit of advice, but if you don’t have any equity in the house, that’s a useless suggestion,” Dvorkin notes of generalizations. “These types of things need to be addressed, and having a credit counselor go through them is the best way I know to get that advice.” The nonprofit Financial Planning Association is a good place to start your search for a qualified CFP in your area (www.fpanet.org/public).

Keep in mind, though, that even among experts, opinions vary. For instance, when it comes to credit-card debt, McNaughton explains, “some experts say to pay the highest-interest-rate balance off first, and some say pay the lower balances off first. I say the lower, because most people become discouraged when they’re not seeing things happen quick enough. I like gold stars. I like to see progress being made.” Clearly, finding the right plan for your personal situation and spending style is key to your success.

4. Put your plan into action.

Once you’ve found your plan, execute it. “You need to pull the trigger and do all that’s necessary to make that option successful,” Dvorkin says. For instance, McNaughton recommends always paying more than the least monthly amount due. “The idea is to pay at least double the minimum,” she says. “A $2,000 debt would take about 16 1/2 years to pay off and [would cost] $2,500 in finance charges if you just paid the minimum and never charged again. If you paid an extra $5 on that example, it would knock off five years. An extra $10 would knock off eight years.”

5. Review, review, review.

A maintenance plan is essential to keeping yourself debt-free. In financial terms, that means reviewing both your budget and your debt-solving plan every month, and avoiding the habits that landed you in the hole in the first place. “If you use a credit card, pay it off that month,” Dvorkin instructs. “If you start adding on debt again, you’re going to be in the same shape, maybe worse.”

Once your debt is liquidated, McNaughton recommends keeping a close watch on your credit. “After a person has paid off debt, I recommend they get a copy of their credit report, to make sure the agencies have reported that all their accounts have been paid off,” she says, noting that consumers are entitled to a free report from each of the three credit unions (Equifax, Experian, and TransUnion) every year.

Equally important to the maintenance plan, says Dvorkin, is “training yourself to live on less.” Most of us can trim 15 percent of our monthly spending and not even feel it, he says: “You won’t even notice, I’m telling you. Do you really need that Starbucks, or can you drink the coffee in your office? No. You can cut back a little and not even notice.”

Expert-Recommended Resources

• The Get Out of Debt Kit: Your Guide to Total Financial Freedom, by Deborah McNaughton

• McNaughton’s Professional Credit Counselors Inc., www.financialvictory.com

•Credit Hell: How to Dig Out of Debt, by Howard S. Dvorkin

• Dvorkin’s Consolidated Credit Counseling Services, www.consolidatedcredit.org

• Green With Envy: Why Keeping Up With the Joneses Is Keeping Us in Debt (Warner Books, $25), by Shira Boss

• www.jumpstart.org