In Part I of this article, we looked at the importance of understanding and analyzing your income and expenses. We then discussed how to develop a budget to maximize your income and control expenses in order to reach financial freedom as quickly as possible.

In Part II of this article, we will discuss how to reduce or eliminate bad debt in order to reach your financial goals more quickly.

Reducing or Eliminating Bad Debt to Boost Budget Planning

In the first part of this process when you examined your income and expenses, I’m sure there were a number of shocking expenses that were uncovered. Who knew that a Starbucks was costing $120 a month, the frequent ATM withdrawals amounted to $500 very quickly, and dining out was the biggest monthly expense.

Hopefully, after you noticed this and began to work on your budget a realization was made that money can be better used towards building your wealth, and you committed to reducing frivolous spending. On a side note, it is okay to spend money on Starbucks and go out to dinner, or whatever your poison is, as long as you truly enjoy, find value in the purchase, and you’ve budgeted for it. Treat yourself – after all, you’ve earned. But, simply wasting money on things you can live without is foolish.

Now that you have reduced your expenses to a reasonable level, you need to find ways to boost that investment bucket in your budget. There are a couple obvious ways to do this. Increase your income through either a higher paying job or a part-time business, and reduce your bad debt. Since the US economy is hemorrhaging with debt, this is what will be the focus here. But, first, a quick note about debt.

I mention “bad debt” because debt can be good. For example, credit cards that offer rewards or cash back are providing excellent programs for people who actually pay off their credit card balance every month. The credit card company is essentially loaning money to make purchases for 30 days and in turn paying the credit holder for this with rewards. That is an incredible offer. Another example of “good debt” is a bank loan that is used to purchase something that actually pays for the loan and then some. A good example of this is a mortgage for a income-producing rental property. Good debt is debt that is used to make money, whereas bad debt costs money.

Back to reducing bad debt. Let’s look at a person we’ll call “John,” who was killing time at a consumer electronics store one day and ended up finding a great deal on a plasma screen TV for $2,500. He made the purchase with his credit card, which has a 10% interest rate, and every month his bill comes in the mail to tell him his minimum payment of $50 is due. John makes his minimum payments regularly, but never actually makes any progress on paying off his credit card. In fact, at this rate, it would take almost 17 years to pay off the TV, or $10,200 for a TV that likely won’t be so nice any more. Multiply this expense with many others across several credit cards, and our friend John is in deep trouble chasing his own tail just trying to pay off his credit cards. Does this sound too familiar? Sadly, most people are spending their entire life paying off items they purchased that they probably didn’t need in the first place and have no value once they are paid for.

By the way, department store credit cards that tease you with a 10% discount on purchases are generally the highest interest rates. And, unless you paid off your purchase immediately, chances are the department store earned that 10% back from you many times over.

There are several methods to get out of credit card debt. The simple way to get ahead is to do the following:

• Order a copy of your credit report from www.annualcreditreport.com.
• Pick one or two credit cards that you will want to keep
• Close the account on every other credit card that has a $0 balance. Having too many credit cards can adversely affect your credit score.
• Call the customer service line for the two cards you want to keep and tell them you want to close the accounts because you received an offer for 0% APR for a year on all purchases and balance transfers. Most likely they will want to keep your business and offer you the same plan. If not, pick another card and try again.
• You may want to try to raise your credit limit while you are at it, depending how disciplined you are. If a higher limit means you will spend more, forget it. However, maxing out your credit cards can also affect your credit score, so it can be a good thing to have a higher limit if you keep your balance proportionally lower.
• Transfer all of your credit card balances to your one or two selected cards that now have a 0% APR, and close the accounts on those cards that the balance was transferred from.
• Stop using your credit card to make purchases for items you do not fit in your monthly budget and you do not intend to pay for in full on your next bill.
• Pay off these cards by applying as much money as you can on a monthly basis to get a $0 balance as quickly as possible.

If that doesn’t work for you, try snowballing your debt payments:

• Call your high interest rate cards to try to negotiate the rate down.
• Transfer the balance of the high interest rate cards to the low interest rate cards.
• Make a list of all your credit cards, ranked in order from the highest interest rate to the lowest interest rate.
• Every month, pay as much as you can on the card with the highest interest rate, while paying the minimum amount on the other cards.
• Once the balance on the card reaches $0, apply the amount you used to pay the previous card towards the next card on the list. Now you should be paying the amount from the previous card + the minimum payment you were paying before on the card.
• Repeat until all cards are paid off in full

These are just a couple strategies that can be modified according to your situation. The important thing is to have a plan to eliminate debt, and make a commitment to only use your credit card for purchases that fit within your budget. This will allow you to benefit from the generous reward plans that many credit card companies and banks offer.

Reducing or eliminating your debt will free up more cash for you to apply towards smart investments, which will in turn assist you in reaching your financial goals much, much quicker.