Erase debt problems while you can

With the economy slowing, now is the time to quickly reduce excessive household debt.

Household debt has surged during the good times to record levels, while the nation's savings rate fell to record lows in 2000. Families currently in decent financial shape may find themselves in serious financial trouble if jobs start disappearing or other hardships occur.

Some economists have said the high level of personal debt could be the economy's Achilles' heel as the economy softens.

Although most debt problems are occurring among households with an income below $50,000, according to the Federal Reserve, higher-income households aren't immune. News stories last year reported that an Alaskan couple who earned a six-figure income declared bankruptcy after racking up $461,000 in credit card debt using 68 credit cards.

Reducing problem debt isn't fun, nor is it always easy. But it is better to reduce it now before a soft economy possibly reduces your income. The first step is to review your finances to see if you are vulnerable to debt problems.

Certified financial planners recommend that no more than 10 percent to 15 percent of a person's take-home pay should go to non-mortgage debt. That means student loans, car loans, personal loans, credit cards and so on. As a rule of thumb, many planners recommend that people aggressively target any debt whose interest rate runs 10 percent or more.

A note of caution here: Many people have refinanced their home mortgage or taken out second mortgages, and more families may refinance as interest rates drop. The potential problem with this is that families often roll piled-up credit card debts, car payments or other non-mortgage purchases into the refinancing, thereby "masking" their non-mortgage debts inside their mortgage.

If you have excessive debt, what do you do? Here are several ideas from Dennis Filangeri, a certified financial planner based in San Diego.

Make a spending plan to document more precisely your income and your expenses. Identify monthly expenses that you can eliminate or reduce in order to minimize the accumulation of additional debt and to free up funds to pay down existing debt. Delay buying a new car or new clothes, for example, or carry a brown-bag lunch instead of eating out. Imagine that you're on an emergency budget should you lose your job or suffer a decline in income from such things as fewer overtime hours. What are the bare-minimum expenses you would have to meet, and what could you do without?

Get under control the things that are causing you to get into debt in the first place. Are credit cards the problem? Limit their use or quit using them entirely. Start paying off new charges every month so you don't pile up the principal on which you're paying interest charges. Pay more than the minimum payment.

Put your tax refund, year-end bonus or any other extra monthly cash toward your debts. If you do have a tax refund, consider adjusting your withholding in order to free up income sooner.

When paying off debts, start with the highest-interest debt first, or the one with the lowest balance so you can feel good about paying off a debt quickly. When a debt is paid off, put the payments you were making on that debt toward the next debt, and so on.

Get a second job or work extra hours to pay off debts. You're more likely to be able to do this now, while the economy is still relatively strong.

Consider debt consolidation, but be cautious. It may make sense to consolidate several high-interest credit cards onto a single lower-rate card. Just be sure you cancel the old cards so you don't rack up new debts on them.

A home equity loan can work, too, but remember that you are putting your home at risk if you can't pay off the loan. Also, be sure that the total payments under a consolidation loan are smaller than the total payments of the individual loans over the same loan period. Don't consolidate debt you typically aren't paying interest charges on, such as doctor or lawyer's fees.

For more serious debt problems, consider working with a nonprofit credit counseling service or support groups such as Gamblers Anonymous or Debtors Anonymous.

Zall, Bureaucratus columnist and a retired federal employee, is a freelance writer based in Silver Spring, Md. He specializes in taxes, investing, business and government workplace issues. He is a certified internal auditor and a registered investment adviser. He can be reached at miltzall@starpower.net.