A MOTLEY FOOL SPECIAL REPORT. Get out of debt

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A M O T L E Y F O O L S P E C I A L R E P O R T

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2 The Motley Fool Get Out of Debt fool.com

My “Take acTion” Plan

1. Stop using your cards.

The last thing you want to do with credit card debt is add to it. Take all your credit cards out of your wallet or purse and leave them at home — safely out-of-reach behind a major appliance or trapped in an ice block in your freezer. (You may want to keep one for emergencies. And, no, a really great sandal sale or a cool new Bluetooth-enabled gadget does not qualify as an emergency.)

2. assess your debt-to-income ratio.

It’s time to face those debt demons and get a bird’s-eye view of where you stand. Some debts, like mortgages and student loans, are just part of life. It’s the other ones (credit cards, car loans — a.k.a. “bad debt”) that can bring down your financial house of cards with an innocent sneeze. Use the

Debt-to-Income Ratio Worksheet to add up the latter and see where you stand.

3. Dig into the details.

Don’t just throw yourself at a mountain of debt without preparation. Knowing the dirty details about your enemy is half the battle in conquering credit card bills. How many cards do you have? What interest rates do they charge? Which have the highest balances? Are the payments flexible? Is the debt “secured” or “unsecured”? Once you complete the Get to Know Your Debt Worksheet, you’ll know exactly what you’re facing.

4. Reduce your interest rates.

One phone call can save you thousands of dollars. Sounds like marketing hype, but it’s true. Getting your lender to lower your interest rate will fast-track your debt freedom plan. The Dialing for Dollars Worksheet will help you make the calls.

5. Plan your attack.

It’s time to form your battle plan. Pick a date. That’s when you’ll celebrate “Freedom From Debt Day.” The Plan Your Attack Worksheet will crystallize your calendar.

6. Schedule a few (inexpensive) rewards.

Debt boot camp can get dull. Without a few treats along the way, you risk slipping back into old spending habits. Use the Plan Your Rewards Worksheet to celebrate your hard-won progress.

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BReakDown of “BaD DeBTS”

In order to get where you want to go, you need to know where you’re starting.

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list all the bad debts (credit cards, store charge cards, loan shark loans) you currently have.

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next, let’s take a look at what kind of interest you’ll pay this year. This’ll involve a little math, but don’t worry. Just grab a calculator and follow our example.

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finally, on the next page, we’ll calculate your debt-to-income ratio.

Bad Debts (credit cards, store charge cards, car loans)

name of card/loan amount owed interest rate estimated annual

interest Payment

Example: First Bank of Firstness Visa

$4,379.27 17.65% $4,379.27 x 0.1765 = $772.94*

Total: $ Total: $

*This is just a rough estimate of the amount you would pay in interest if your balance (amount owed) remained unchanged for one year. Ide-ally, you’ll pay down your balance over the next year, reducing your total interest payments from this estimate. On the other hand, if you miss payments or charge more on this account, your total interest could be higher.

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Do you have Too Much BaD DeBT?

Look at your total bad debt — not your interest payments, but the debts themselves — and compare this num-ber to your annual after-tax income. Here’s how you do that:

Example: Total bad debt:

Total after-tax annual income: Bad debt-to-income ratio: ($6,437 ÷ $30,000) =

Danger, Will Robinson! A 21.4% bad debt-to-income ratio is awfully high, especially if it’s all — or mostly — credit cards and charge cards. The ideal number here is zero, but at the very least you want to keep bad debt — including car loans — to 15% or less of your after-tax income. Otherwise, your debt payments will eat up too big a chunk of your paycheck. Sure, some banks will advise you to go well beyond 15%, but remember who profits if you stay on the debtor side of the divide — they do!

ReaDy? iT’S youR TuRn

My Total bad debt:

My Total after-tax annual income: My Bad debt-to-income ratio: $__________ ÷ $__________ =

If you’ve been reading other financial advice, you may think we’ve made a mistake. A common suggestion is to divide your after-tax income by your annual debt payments (the money you have to come up with just to pay the mortgage, other loan payments, and credit card minimums). Because we’re aiming to get you out of debt — not to just leave you afloat so that you remain enslaved to the bankers — we’re doing two things differently:

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we’re leaving good debt out of the equation. It’s tougher to give a rule of thumb for the whole ball of wax. Suffice it to say that if you’re having trouble just paying the minimums — you’re not regularly saving or paying down debt — you’ve got too much debt period, good or bad.

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we’re dividing your after-tax income by total bad debt because we want to focus on eliminating

all of the bad debt as quickly as possible, not just keeping up with the payments. Your key takeaway here is that your bad debt-to-income ratio needs to head toward zero.

$ $ % $6,437 $30,000 21.4%

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GeT inTo youR DeBT DeTailS

Don’t get overwhelmed by the number of columns on the following table.

You’ve already figured out what goes in the first three columns in step 2 with the Debt-to-Income

Ratio worksheet. So just transfer that information below. Only this time organize your list in order of highest to

lowest interest rate.

Next let’s fill in the following two columns

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Secured or unsecured

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flexible or inflexible Payment Schedule

1. Is thIs secured or unsecured deBt?

First the easy part: Credit cards are unsecured debt. If you get behind on payments, the bank and its bill col-lectors will remind you relentlessly. But that’s really all they can do to you when the debt is unsecured. In general, any loan for which you put up some kind of “collateral” is a secured loan. The most common types of secured debt are home mortgages and car loans. If you violate the terms of these loans, the bank can come looking for your house or car, take possession, and sell it to recoup their losses.

2. how flexIBle Is the repayMent plan?

The ultimate in flexibility is the credit card. You only have to pay a tiny “minimum” each month (though we hope you gather that we caution against paying this way). Sometimes student loans have flexible repayment options too, such as the ability to suspend payments for a few years if you go back to school. Installment loans, like home or car loans, are on the other side of the flexibility spectrum. Unless you refinance the loan — write out a whole new contract — you more or less have to make the required payments on time, without excuses.

To-Do:

Go through your list of debts on the Get to Know Your Debt worksheet and mark each with an “S” for secured or a “U” for unsecured.

To-Do:

Go through your list of debts again. This time, mark the flexible ones with an “F” and the inflex-ible ones with an “I” in the final column. Leave the “negotiated interest rate” column and the last two col-umns blank for now — we’ll get to those in the next two sections.

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card /loan amount

owed interest rate negotiated interest rate (if any) Secured / unsecured _______ S / uS flexible / inflexible payment schedule _______ f / if number of months until paid off Monthly pament due (total owed ÷ months until paid off)

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ReDuce youR inTeReST RaTeS

Most credit cards charge interest anywhere from 0% to 20%. Heck, we’ve seen cards that charge as much as 41%! But you can negotiate with your credit card company for a lower rate, particularly if you’ve had any of your cards for a while.

Call them up to demand a lower rate. Shoot for 9% or 12%. You’d be surprised at how easy it is.

here’s how:

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1. Take out your Get to Know your debt worksheet.

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Start with a card that you’ve had for a while, and to

which you haven’t made any late payments.

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flip over your card and dial the customer service number.

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Start negotiating. Consider this sample script — our exclusive Rate Negotiation DialogueTM_{at right — for} ideas on what to say.

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Record your new rates on the Get to Know Your Debt worksheet. If you don’t get what you want the first time, try to get another customer service rep or supervisor on the line. Still won’t budge? Mark your calendar and call back in a few months.

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you might want to combine your debts onto one or two of your lowest rate cards if you can. (If you’re maxed out on those cards, then forget it.) Simply call your lend-er and ask how to transflend-er funds. And be sure to find out what fees — if any — you’ll be charged. Weight those against any interest savings before making the move.

Rate Negotiation Dialogue

TM

sample script

you: “I just got this incredibly great offer in the mail for a new credit card that has an introductory interest rate of only 5.9%! I don’t really want to switch cards, since your service has been great. But even though I’ve had your card for three years, I’m still paying a 17% rate on my balance. I’m going to have to transfer my balance unless you can lower the interest rate.”

Them: (The sound of a flurry of keyboard rat-a-tat-taps and your credit and payment history being scrutinized.) “Hmmm … well, that is the going rate … let’s see …”

you: “Sure, but I can pay a lot less in interest if I transfer my balance. I really need you to reduce the rate to 11% or so.”

Them: “Let me check with my supervisor … OK, how about 11.8%?”

you: “No problem.” (Now go treat yourself to a snack — a cheap one! — for saving some bucks!)

This may not work as well if you’re frequently late with your payments and deeply in debt. But it can’t hurt to at least ask for an interest rate reduction on all your cards. If you have a solid track

record, don’t litter, are generally polite, or can affect a halfway decent French accent during the call, your lender should be willing to offer you a lower rate to keep from losing you to the competition.

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SeT DaTeS anD oRGanize youR Pay-off ScheDule

You’re in the final lap! You’ve faced your balances, organized your debts from highest to lowest interest rate. And you’ve called a few of your lenders to discuss lowering your interest rate. You rock! It’s time to kick your debt-payoff plan into high gear.

1. Take out your Get to know your Debt worksheet.

We’re going to fill out the final two columns.

2. Pick a timeframe during which you’d like to have each debt paid off.

Record that in the next-to-last column. Generally, you’ll want to start by paying off the card with the highest rate first, and then the next highest, and so on. (After all, the high-er the inthigh-erest rate, the less of your monthly payment goes to paying down your balance.) However, if you want a quick boost, go ahead and pay off a card with a low balance, just to have one paid-off card under your belt.

3. in the last column determine your monthly debt payment amount.

(It’s a rough number because we’re not including the interest you’re accruing on your remaining balance.) Simply do that by dividing the total amount you owe by the number of months you wrote in the previous column.

4. Begin blitzing your first debt with everything you’ve got.

Got a tax refund? Send it to card No. 1. A few extra bucks from brown-bagging your lunch? Mail it off. Concentrate all your extra dollars on one single debt until it withers to nothing. Obviously, you want to pay the minimum amounts (on time!) on the rest of your cards during this blitz.

5. lather, rinse, repeat.

Move on to the next target on your list. (Yes, it’s that simple.)

6. keep your eye on the dealers.

As you stick to your plan, be sure to monitor the terms of all of your debts on a regular basis. Lenders are quite fond of changing the rules (interest rates, grace periods, due dates) on a whim. You don’t want to get caught off guard.

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aDD SoMe zeST To youR GeT ouT of DeBT Plan

You’ve got a handle on the amount of your debts and probably are getting a good sense of what it’s gonna take to get you out of a credit hole. Developing a budget, saving money, and sending out payments make for a pretty dull life. You have to let a little sun shine in, or you’re bound to collapse under the strain and give up.

One good way to add some zest to the game — while providing a motivational edge at the same time — is to come up with a fun one-year (or however long it’s going to take) savings goal.

So, sit down and think about it. If there’s a spouse and children involved — who will surely be wondering why money is suddenly so tight — get them in on the reward planning too. Come up with something fun that will keep you focused and help you stand firm in moments of potential weakness. Make it attractive, write in the total amount you’ll need to pay for the reward and divide that number by the number of months you have to achieve your goal. Remember … no cheating! If you haven’t achieved your get-out-of-debt goal, postpone the reward. (Sorry, but those are the rules. We didn’t make them up.)

There’s no substitute for putting your agreed-upon reward in writing for all to see (even if it’s just you looking!). See-ing it in black and white makes it real. Record your goal in the space below. Then cut it out and hang it on the fridge.

SeT SMall GoalS

As you’re working toward your goal, you’ll probably need a few pick-me-ups to keep up the momentum going. Set some short-term goals — we find that weekly is a good measure — so you can watch your progress toward a debt-free life. Your weekly goals could be:

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Saving a certain dollar amount to put toward your debt

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Avoiding putting any new purchases on the card

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Negotiating a lower interest rate

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Transferring your balance to a lower-interest rate card

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Brown-bagging your lunch and adding the lunch money to your debt payment pile

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Baking cookies (or some other homemade treat) instead of buying a gift for some occasion

ScheDule SMall TReaTS

What’s the reward for achieving these mini goals? Make it something inexpensive, but enjoyable. Maybe it’s a sundae from your favorite restaurant, or a froo-froo coffee drink one day before work. Perhaps it’s a magazine, a free hour to read it, or a day off from chores. Record your mini rewards on the next page.

On the next page record your mini goals and rewards for each week of the month. If you get ambitious, plan your mini goals for the next few months. As you pick off each one, mark it with a big, black X and dive into your reward!

If it takes more than a week to complete the mini goal, just carry it over into the next week until you’re done. Remember, hold off on the reward until the goal is achieved. Yes, we’re watching you. But more importantly, we’re rooting for you.

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A MOTLEY FOOL SPECIAL REPORT. Get out of debt