WMDT 47 News - Delmarva's Choice5 financial planning steps to a healthier new year

By Andrew Housser

With a fresh new year ahead, January is the traditional month to make resolutions -- and no resolution is more profitable than the decision to get out of debt and begin planning a smarter financial strategy. The timing also is great this month, with most people are beginning a fresh year of tax deductions and retirement plan options. As well, many are facing a mountain of holiday credit card bills that can serve as powerful inspiration to put finances in shape.

We've broken down the process of financial well-being into five steps. Take action on these, and your financial resolutions for 2012 may be complete.

1) Make a plan.

Everyone has goals, whether to buy a home, take a vacation, or be able to retire comfortably. As the year begins, take a fresh look at your income and expenses so that you can plan how you will move toward your goals. Begin by listing your ongoing, "fixed" monthly expenses such as rent or mortgage payments, and your income. After paying fixed expenses, your remaining income can pay for variable and optional expenses, including groceries, saving (variable but not optional!), entertainment and shopping. Prioritize the optional items that are important to you. Then keep track of your spending every day, week and month throughout the year. Some people find it helpful to post their spending plan and goals in a visible place (like the refrigerator door) to keep them top of mind.

2) Give yourself a safety net.

Each month, save something to start building your safety net. Ideally, have this money automatically transferred to a savings account. Even if you can manage to save only a few dollars a week, begin to get in the habit. Gradually, you will build up an emergency fund, and will be able to rely on that "cushion" instead of a credit card when you are in a cash crunch. This action in itself will help you to stop building credit card debt. Commit to yourself that ultimately, you will save 10 percent to 25 percent of your income.

3) Do more than the minimum.

Pay more than the minimum payment on every bill. Even just adding $10 to your payment -- or rounding payments up to the next $10 or $100 increment -- will knock out debt much faster. Take on extra work, sell possessions you do not need, and apply unexpected money like a raise, bonus or gift to paying off credit-card bills.

Two methods can work to eliminate credit card debt. To be effective, both strategies require you to continue paying the same monthly amount toward your debt until all debts have been paid off. Once one credit card has been paid off, keep paying the same total monthly amount (or increase the amount if you can afford it). You'll get out of debt faster and reduce the overall cost of your debt.

A) Avalanche -- The avalanche method involves paying off credit cards in the order of highest interest rate. First, decide how much you can afford toward your debt each month. From that total, allocate enough money to make minimum payments on every credit card. Send any additional available to the card with the highest interest rate. Repeat this process every month until that credit card has been paid off. Then add every dollar you were using to pay off the highest-interest card to what you were already sending to the second-highest-interest credit card. Keep following this strategy -- paying the same amount each month toward your debt -- until all debts have been cleared.

B) Snowball -- The snowball method involves paying off the lowest debt amount first. First, just as you would with the avalanche method, budget enough money to pay the minimum on all cards. Then apply any remaining funds toward paying off the credit card with the lowest balance. Once you have paid off the first credit card, continue paying the same monthly amount you started with. Follow the same strategy as the first credit card: Pay only the minimum payments on all other cards while using all the remaining funds to pay off your second-lowest debt.

The snowball method can be more costly over the long term than the avalanche method, because you might pay more interest. But many people believe that seeing small debts paid down helps motivate them to stick to the discipline of paying down debts. In fact, some recent academic studies have confirmed this hypothesis. If you are not extremely self-disciplined, consider the snowball over the avalanche method, as it will likely increase your chances of success.

4) Participate in a retirement plan.

Especially if your employer matches contributions, contribute to a retirement savings plan. If you are on your own for retirement savings, invest in an individual retirement account (IRA), Roth IRA and/or retirement plan for self-employed persons. The earlier you invest for retirement, the more likely you are to have a secure retirement.

5) Be honest about your debt situation.

From late 2009 through third-quarter 2011, consumer revolving debt fell by $76 billion dollars. But part of the reason is that more consumers have been completely unable to pay their bills. Credit card charge-offs -- debt the credit card banks write off as likely to never be paid -- were higher in each of the past six quarters than they had ever been on record. Charge-off rates following the "Great Recession," which some economic analysts estimate ended in the second half of 2010, were double or triple what they were over the past 25 years. If you evaluate your situation and feel that your chances of getting out of debt are hopeless, take action to get help. Many options exist, such as borrowing money, asking lenders to work out a payment plan, or in some cases, debt settlement or credit advocacy help. 

Remember, financial health is a process. Keep your eye on the long term, stick to your goals, and you can find success -- and get out of debt -- starting in 2012.