Tips to help you pay down debt – and save

Debt is a drag – in more ways than one. Monthly payments can challenge your budget and make it difficult to save. High interest rates and lengthy repayment terms only add to the burden.

With the economy in the midst of a recession, many Americans are now discovering the downside of credit and are looking for ways to reduce personal debt. Here are tips to help you pay down debt while also freeing up money to save – so you can take the necessary steps to regain control of your financial future.

1. Swap high-interest debt for lower-cost loans. In today's environment, the interest you pay on debts – especially credit cards – typically exceeds what you could earn on savings. So it makes sense to focus on paying down these accounts to get ahead of the debt curve. Consider replacing high-interest debt with low-interest loans to help reduce costly finance charges. Then use any extra dollars you save or proceeds you receive to pay down existing debt – not to make new purchases. And don't build up the original debts again.

   Lower-interest options to consider:

   • Take out a home equity line of credit. A home equity line of credit² allows you to take the equity in your house and use it for other purposes. Once your line of credit is established, you can access the funds to pay down high-interest debt.

     For example, if your home equity line of credit has a fixed rate of 7% and you use those funds to pay off other debts, including a credit card balance with an 18% variable rate, your savings would be substantial. Unlike credit card interest, the home equity loan interest may be deductible if you itemize your deductions on your tax returns.

     One additional benefit: you only pay interest on the amount of the credit line that's used. For example, if you have a $30,000 credit line but only used $10,000, you will only pay interest on the $10,000 amount. Keep in mind that home equity loans can be set up with either a fixed or variable rate, and each offers certain benefits, so be sure to weigh both options to determine which one is best for you.

   • Take advantage of new opportunities to refinance your mortgage. Home values have deteriorated rapidly in recent months, causing many homeowners to owe more than 80% of the current assessed value of their homes. Most lenders require homeowners to have at least 20% equity in their homes to be eligible for refinancing, and decreased values have made it even more difficult for homeowners to qualify. But recent opportunities resulting from President Obama's Making Home Affordable (MHA) program make it possible to refinance your existing mortgage even if you have no equity – up to 105% of your home's value. This means you may be eligible to secure a new loan with a more favorable interest rate and lower monthly payments. Ask your mortgage provider if you qualify.
2. Renegotiate with lenders. You might be surprised to discover how flexible some creditors can be. Mortgage terms can be renegotiated and credit card rates lowered – sometimes all you need to do is ask. If you're unable to get the creditor to budge, take your business elsewhere if you can. For example, transfer any credit card balances to cards that offer low introductory rates – or better yet, a low fixed rate for the life of the balance. Just remember to always make your monthly payments on time or your interest rate and payments will go up significantly.

3. Create a spending budget. Everyone knows how important it is to have a budget to track expenses, but far too many simply don’t have one. Without realizing how much you’re spending each month, “small” expenses can add up. Creating a written budget for your household can help you gain control of spending and identify areas where you can save.

   For example, cutting back on extras such as magazine subscriptions may seem like a small step, but the benefits will add up. Determine where you can make sacrifices and be sure everyone in the family is on board. Such actions may also help your children understand the importance of taking personal responsibility for their own finances as they grow up.

Paying down debt is critical in today's challenging environment, but maintaining some credit is also important. Suppose you were to lose your job or face an unexpected need for a large amount of cash. Credit can help temporarily tide you over if times get really tough. So keep your zero-balance credit cards rather than closing out your accounts. Even use them on a regular basis – and pay them off right away – to maintain a good credit standing.

Saving is the other side of the coin

Nearly everyone can save more on a regular basis than they presently do. While applying the tips above can help free up money so you can save more, you may want to consider these additional options:

• Automatic contributions to employer-sponsored savings plans. One of the easiest ways to save is by contributing to an employer-sponsored savings plan. Any amount you invest is automatically removed from your paycheck on a pre-tax basis, making it seamless and simple to manage. Make sure you invest at least enough to receive the full employer match or you could be missing an opportunity to get free money.
• Systematic deposits to savings accounts. There are other simple ways to ensure you consistently save. First, take steps to cut down on your expenses so you can set aside extra money. Then, set up automatic transfers on a weekly or monthly basis to your account.

For example, let's say your family of four eats out twice each week at an average of $35 per meal. If you cut out one of those meals each week by eating at home instead, you would save $1,820 in a year. Now, instead of waiting until you have $1,820 at the end of the year and making a lump-sum deposit, set up automatic monthly deposits of $140 (representing one $35 family outing per week). This will ensure your savings account grows over time without impacting your budget. Once you’ve adjusted to your new routine of eating out only once per week, move on to additional saving opportunities, such as reducing your cable bill or switching to public transportation. Just remember to use every extra dollar to either build your savings or pay down debt.

With creativity and discipline, you can succeed at reducing your expenses so you have more money to pay down debt and build your savings. This is especially important in today's challenging economic climate. Talk to your Ameriprise financial advisor about these and other steps you can take to help you regain control of your financial situation.