When you are formulating a credit card debt reduction plan, you have to ask yourself whether you want to reduce your debt as quickly as possible (ie whether cash flow is a priority) or if improving your credit score is more important. That is because your decision will determine how you approach your plan.

If you want to reduce your credit card debt as soon as possible, then pay off the card with the highest interest first. Then work on those with the next highest rate and so forth.

However, if your goal is to get your credit scores up, then it is probably better to reduce debt on your card with the higher credit utilization. This is because credit utilization is one of the key factors in determining your credit score. Once you have reduced the utilization to about 25% to 30%, then move on to the card with the next highest utilization issue.

If improving your cash flow is a priority, then you may want to consider consolidating your debt into a 0% balance transfer card (but do it only once). But if improving your credit score is a priority, then consolidating your debt may not such a good idea because you will have a very high credit utilization on one card but very low utilization on the rest of your cards. The are distinct ‘gaps’ in the credit utilization ratios among your different cards.

But first a word of caution. If you want to do a 0% balance transfer on a credit card, then do it once only. Then get on a systematic plan to reduce your debt. Many people keep playing the zero percent balance transfer game and what it does is that it ends up possibly lowering your score because you end up utilizing too much of your credit on one particular card. This especially happens when you transfer debt from a high limit card to a lower limit card. BUt more importantly, playing the merry go round may blindside you from reducing your debt.

The decision to consolidate credit card debt and which card to pay off first depends on whether improving your credit score is more important or reducing your debt quickly. Think about this issue carefully before formulating your plan.

Last Thursday was my 10th Year Wedding Anniversary with Mrs Credit Card. We went away to Strausburg, Lancaster County (where the Armish live) for a Spa get away. Aside from the wonderful spa treatments, we visited an Amish Village where we were given a quick tour and education about how the Amish people lived. To say it was an eye opener was an understatement.

After giving us a history of how the Amish people came to America from Europe, the tour guide then showed us how the Amish lived. Man, was this extreme frugality in action. Here are a few rules and points about their lifestyle.

1. They do not use electricity - just gas. Hence, you can see huge gas tanks by an Amish home.

2. No electricity means no televisions, no cable TVs, no internet connections.

3. They travel around in buggys (little carriages and horses). They can catch a ride in cars, but not own one!

4. They do not own any life or medical insurance. If they have an accident and the medical bills are too high, the church and community will hold fundraisers.

5. Most Amish study until a middle school equivalent and then move on to their “chosen profession”. (No worries about funding college education!)

6. We were also given a “tour” of a typical family house. One of the things that struck me was that everything in the house has to have a purpose or function. That means no decorative stuff or no buying stuff on impulse.

7. They dress simply and although there are different sets of outfits for married and single folks. No spending on extravagent clothes.

(Above left and right pictures) - These are pictures of an Amish kitchen. The kitchen is the only heated place during winter and is where most family activities are. Note the gas stoves and gas lights.

(Above Left) - blanket to keep warm during winter. (Above right) - Typical clothes of the Amish

(Above Left) - An old gas washing machine. Nobody makes them anymore. But apparantly, there are people who know where to get spare parts! (Above Right) - Transportation - No worries and debate about buying new car or used! No wasting time over getting the lowest rate for your auto loan!

Look, most of us are not simply going to live a life like that. But for those who are finding it difficult to reduce your spending and your credit card debts, there are lessons to be learnt from the Amish. Firstly, we can actually do without what many of us would consider “must have items”. Or at least, we can do without them for a short period of time. Cancelling your cable or magazine subsription is one way to cut some fat from our budget.

Another interesting thing about their house is that every thing in it has to have a purpose. How many of us simply buy something because of impulse purchase? Or simply to decorate the house. Look, if you have lots of cash or cash inflow, what you spend on is never an issue. But if you are looking to reduce debt, getting into the habit of not buying stuff for buying sake will go a long away to better your finances.

I hope this post is an inspiration for those looking to trim some fat from their budgets. And Oh! I forgot to ask if Armish poeple carry credit cards!

Choosing a credit counselling firm is not easy as there are many not so reputable firms around. If you are able to pay more than the minimum payments for your debts, you should generally avoid this route and instead trim your budget and have a more aggressive plan to pay down your debts faster.

But here are some check points to consider :

Is the credit counselling firm accredited?

You should check with the National Foundation for Credit Counselling or the Association of Independent Consumer Credit Counselling Agencies. Go to the following websites for more information - www.nfcc.org, www.aiccca.org.

What fees are being charged?

Well, when you have serious problem paying off your debts, the last thing you want is to pay more “unnecessary fees”. $50-$75 to set up a plan would be reasonable.

Ask When and How Much will the creditors get paid?

Many credit counselling firms get a monthly payment from their customers and then threaten your creditors to miss payments if they do not negotiate the amount of debt owed. Missing payments or having late payments can dramatically lower your credit scores. Ask and have in writing when and how much will creditors be paid.

Check the Better Business Bureau

Call the BBB in your area and check how many complaints does the firm have against them. You should be take the extra steps and check with your State Attorney’s Office to see if there are any regurlatory actions filed against them. Yes, it is quite a bit of work. But this can save you from unpleasant experiences down the road.

What do these organizations promise you?

Anyone who promises that there will be no impact on your credit score or if that they will settle your debts for less than you actually owe is probably being very unrealistic. You are likely to end up with massive disappointments with you work with people who overpromise. You should work with someone who lays out the full picture, the best case scenario and the worst case scenario and is honest about the impact it could have on your credit score.

Ask for referrals

Better still, if you know anybody who has been in a similar situation, talk to them about who they used and their experiences. You will pick up a few tips on how to approach credit counselling firms.

Well, you will probably send some time just searching for the right organization to work with. Take your time, do your due diligence and you are less likely to be disappointed.

I was introduced to a lawyer that specializes in helping people with debt. One of the topics that I asked about was about statute of limitations. I learnt a lot just from speaking to him, but I also did my own research on this matter. This is what I found out.

Statute of Limitations is different from the fact that negative items that are more than 7 to 10 years stops getting reported in your credit report. Statute of Limitation refers to the time frame from the date of delinquency which prevents creditors from suing you and taking you to court. (That may not necessarily stop them from harassing you and trying to collect any unpaid debts).

What is also important is that different states have different statute of limitations. For example, Alaska was cited as an example with a relatively short 3 year statute of limitations. Apparantly, different states also have different statutes for either written and oral contract. In some states, credit card debt can be considered either a written contract, an oral contract or even a seperate category.

In some states, you can even restart the statute of limitations if you either make a payment for an old debt or even acknowledge it. (That is why it is sometimes better just to ignore a negative item on your credit report - and let it just be removed after a number of years).

Another complication that can arise is the fact that some people move, but the debt is incurred in another state. I was told that in most cases, it is the state which you are currently living that matters. But that may not always be the case.

After my conversation with this lawyer, it appears you have to do a lot of research and work before you try to repair your credit or even think about negotiating old debts! It is probably prudent to find a good lawyer who is familiar with your state laws to give you the best advice.

I recently attended a meetup with a group of people in serious debt. There was a discussion of what to do and some interesting ideas were brought out. The following ideas probably applies to those who are in a serious cash crunch.

If your present income has taken a hit and you are very stretched, you may have to take some of the following steps to relief your debt payment burden.

1. Get a second job - You will definitely get more income. You have to weight that against the time you have for your family. This is probably the least drastic measure you have to take.

2. Eliminate or reduce your 401k contributions - You can reduce your 401k contributions temporarily until your situation improves. Once your cash flow situation improves, you can resume normal contributions.

3. Negotiate with the IRS - If you really have difficulty with your payments, you can negotiate a payment plan with the IRS. You probably have to get a tax professional for this.

4. Downgrade to a smaller house - If push comes to shove, you can sell your home and move to a cheaper home. This may take a while (given today’s market condition), but should be explored.

5. Selling any high priced possesions - Think second homes, boats or even anything that is simply taking up space in your garage or closet.

These were the few ideas that were tossed back and forth. Please feel free to comment on any other thoughts you have.

When you are having a tough time reducing your debt or are in sort of a cash flow crunch, one of the things you should do is to prioritize the bills you pay. I have listed various bills below according to how important they are.

Must Pay Bills

1. Mortgage or Rent (HELOC) - If you do not pay your mortgage, you risk foreclosure. If you do not pay your rent, you risk eviction. If you cannot afford your mortgage, consider selling your house and move to a less expensive house.

2. Medical Insurance - You risk incurring a disastrous medical bill if you do not have insurance. You have to pay this bill. There are ways to save on medical bills. Examples iinclude having higher deductibles, HSA accounts etc.

3. Child Support - You can end up in jail for not paying your child support.

4. Income Tax - Better pay this one. You risk wage garnishment and potential loss of any tax refund by the IRS.

5. Court Judgement - You risk wage garnishment.

6. Student Loans - The consequences are the same as not paying income tax - wage garnishment and loss of tax refund. By the way, student loans are almost never wiped out even if you file for bankruptcy.

7. Secured Loans (especially on property - like HELOC) - You risk losing your property to repossession. For business owners, it is the same as a loan that is backed by your equipment.

Bills that will hurt your credit score but are not disastrous if you do not pay

1. Credit Card Bills - Well, your score takes a hit, but you will never lose your house or go to court! In fact, if it is your first time with a late payment and you call the company, you may not even have that reported to the credit bureaus.

2. Medical Bills - You might get collection agencies hounding you, but you will certainly not end up in the streets.

3. Legal Bills - Same as medical bills.

Personal Loans - Ditto. Credit score takes a hit. Your banker friend will not be your friend anymore.

Loans from your friends, family members, relatives etc - Well, they are hopefully the most understanding of the lot.

A couple of post ago, I mentioned that I met Mr X at a party and he started talking to me about how he got out of debt because he found out that I had a credit card review site.

One of the things that Mr X did quickly reduce his debt was to sell any unnecessary junk that he had lying around the house. Mr X told me that he was quite a compulsive shopper and bought many unnecessary things and gadgets! But he first had to develop the habit of not spending money impulsively. Then he told me his story of how he got rid of his junk and clutter in his house.

All his electronic gadgets (like cell phones) which he got sick off was sold on ebay. His next big ticket item was his car. Yes his car. He sold his car and bought one that was 12 years old and had 150,000 miles on it. He chose a Toyota Corolla (which he figured was give him less problems and claims that till this day, it has not). He even sold his Rear Projection DLP TV set which he bought on credit and lived for a couple of years without TV (no cable bills either). He managed to raise a few thousand dollars through clearing his whole house of stuff that he did not want or need (including an extra refrigerator that he got free from his old rented house!),

While he still had debt even after this asset sales, it did reduce his debt load and his monthly payments. But more importantly (according to Mr X), it made him realize that he did not need a lot of the stuff that he always buys on impluse. So his advice is that if you have credit card debt, look around your house and see if you could sell anything that you really do not need or have bought on impulse. This may be the quickest way to cut down your debt load.

I recently met a new friend, Tom, through an introduction at a party. Tom is a graduated from college 4 years ago and when I told him I have a credit card review site and personal finance blog, he started talking to me about his student loans that he has to repay and the credit card debt that he has got into during his college years.

Tom told me that when he graduated, he was saddled with about $40,000 in student loans and credit card debt. It was up to his eyeballs and he just did not know how to reduce them in the beginning. But four years later, he had cut his debt by half and it now stands at about $20,000.

Tom said that one of the most important things he did was to actually breakup his debt reduction goals into biweekly and monthly goals. He felt that if he was staring and thinking about the whole amount, he would simply get discouraged and lose his spending discipline. So what he did was to break them down into monthly goals.

To arrive at his monthly goal, Tom set out a detailed budget based on his monthly salary. He made a point not to accumulate any more credit card debt or any other debt for that matter. He had to make some sacrifices. At certain points during the last four years, he had to take a second job and moved in with his parents for a short period. But his goal was to reduce his debt by $500 a month.

It has not been a comfortable ride. Instead, there are lots of sacrifices. Unrepaired stuff in the apartment, driving around a really beat up third hand car are just some of the sacrifices he is making. But Tom does not want to take another four years to get rid of his debt. Hence, he is planning paying off his debt faster.

Tom says that by just focusing on monthly debt reductions, he is essentially taking a big burden and breaking them into “smaller burdens”. By consistently meeting his monthly target, it motivates Tom even more and reinforces his determination to reduce his debt even faster. Tom also does not feel as burdened as before because he knows that if he can just repeat what he is doing every month, he will be out of debt before he knows it. Paying off his debt is as Tom says a “monthly routine”.

When you have credit card debt which you are trying to pay off, everybody will tell you to set up a debt reduction plan and budget and stick to your plan. But when you look at your budget, how do you decide which items to reduce? Here is how I would look at it.

I would first seperate your budget and expenses into 3 groups.

Necessary Expenses

The first group is what I’ll call the necessary expenses. Your mortgage, auto loans, credit card debt, essential utilities, education expenses, groceries, gasoline fall under this category.

Expendable Expenses

The second category of expenses is what I would call expendable expenses. These are expenses you can actually do without. They include cable tv, netflix, gym memberships, club membership etc. These expenses tend to be recurring. These items in the past would have been considered luxuries, but are now considered essential!

Self Improvement Expenses

These expenses include spending on books, seminars, networking events that will help your career.

3 Ways to Deal with Each Type of Expense

There are three different strategies to deal with each type of expenses. For the neccessary expenses, you cannot do without them. But there are ways to reduce these expenses. You can refinance your mortgage, save on your groceries and utilities etc.

It is in the “expendable expenses” where you can actually save the most. Or at least sacrifice them temporarily until your finances improve. Stop going to the gym and work out at home or run outdoors. If you really wanted to, getting rid of your cable tv may lead to a more productive life. Netflix forces you to watch lots of movies where time can be spent at perhaps “money generating activities”.

While, it is tempting to trim all the fat, make sure you do not cut any muscle off! Activities like business networking and self-improvement may help you in your business or career and if anything, you should invest more in yourself.

Conclusion

When I graduated and just started work, I had very few “expendable expenses”. It was only after I had a few salary raises did I start adding some of these expenses. I did not have cable tv for a couple of years. I also stopped paying for my gym membership when I realized that me paying a monthly fee did not force me to work out regularly!. For what it’s worth, looking at my budget this way early in my working life has helped me trememdously in my finances.

How big a mortgage can you take? How much credit card debt can you carry?

Much has been made about good debt versus bad debt. Getting a mortage for your home is “good” while an “auto loan” is bad because your auto purchase will depreciate. But how much debt can you afford. Below are some guidelines that in my opinion, you should consider.

Stability of income

How stable is your income? This is a very important factor. The more stable your income, the higher debt load you can sustain. Doctors, for example, can afford to have a bigger mortgage than most of us. It is not just because they have high income, but also because they have higher income potential that is more stable. Most new doctors who graduate have a ton of student loans. Yet banks are slightly more lenient on them simply because they have high and yet stable income growth ahead of them. Many doctors have high student loan debt, a mortage and very little cash and investible assets in the beginning of their careers.

However, if you are an insurance agent or real estate agent, then your income inherently is less stable (though lucrative). Your ideal debt ratio will depend on your income and assets.

Alternative source of income

Do you have alternative sources of income? Do you have a rental property producing postive cash flow? How much dividends are your investible assets giving you? The more sources of cash inflow you have, the better your ability to take on debt.

What is Your Coverage Ratio?

When bond investors invest in bonds, one of the key ratios they look at is the companys’ coverage ratio. What is the the cash flow versus interest payments? For triple A bonds, it is not uncommon to find coverege ratios of 10. For junk bonds, coverage ratios of 1.2 to 1.5 are not uncommon.

What is your coverage ratio? How much income are you bringing in? What is your interest payment every month. To be even more conservative, subtract all necessary household expenses from your income and use that number to calculate your coverage ratio. Ask yourself what your coverage ratio will be if you take on a loan, credit card debt, or a mortgage? If you coverage ratio will barely be one, then you should reconsider whether or not to take than loan or mortgage. If your coverage ratio is above 3 and you have a stable income, then you will be a lot safer.

What is your Debt to Equity or Asset Ratio?

How much debt you can take is also influenced by what is your net worth. If you have a few properties free and clear, taking on another mortgage may not be an issue even if your income source is not stable. Before you take on another debt, be sure to calculate your net worth, both equity and assets, accurately.

How much cash on hand do you have?

Ford and General Motors are in big trouble for their North American Operations. But has kept them going is that they have tons of cash on their balance sheet.

How large is your emergency fund? How long can you last if your present source dries up? Think long and hard about this when before you take on any new debt.

Summary

To sum up, I think you have to look at a variety of factors before you can decide how much debt you can take - whether it is a mortgage, auto loan or home improvement loan. Look through these factors carefully before making any big decision that will impact your financial future.