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Debt reduction pyramid strategy

Sun Sep 24, 2006 07:09PM | By Tony

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Debt reduction is difficult when you have several credit cards and carry balances over from one month to the next. Or you have several personal loans or even installment loans like a car loan. Whenever you are paying high interest rate, debt reduction pyramid is the sound strategy to achieve ultimated debt relief. You need to be very disciplined and patient, especially if your debt is large.

So suppose you have a pyramid of debt. Here is what you do to dismantle it:

Start from the top of the pyramid. The first thing is to pay off the smallest credit card balance or loan by making larger than minimum payments. Call it prepayments. Pay only minimum payments for other credit cards and loans. The consistency is the key.

Got it? Call it debt tree instead. Suppose you have three loans. The smallest is the top of the tree. The second one is the trunk. And the largest one is the root.

Once done with the smallest loan, get to the next higher loan. Use all the money that you have to pay it off. Add the money you used to pay the smallest loan to it, money you use for cigarettes, junk food. Switch to the cheaper gasoline grade.

After you eliminate this debt, go to the largest. Add payments from two paid off loan balances to the minimum payment. Find another job, don't go out for a month.

Your debt tree is likely to have deep roots. Do it until all your credit cards and loans are paid off. Thus you become debt free.

Once you are debt free, cut your credit cards except two with the highest credit limits. You need to keep them open and carry a balance of no more than 35% of the credit limit. That will improve your credit score. If your credit limit is $1,000, don't carry a balance of more than $350. Once you credit score is improved, call the credit card issuers and ask for a lower interest.

DO NOT close all credit cards, as some "experts" foolishly advise. These days it is very hard to live cash-only and smartly used credit cards help build, reestablish and maintain your credit.

With that said, we have a problem with this pyramid or tree approach. To kill the tree, better start from the root - from the largest debt balance. Put all the money into it. It will save you money. If you pay smaller loans first, making only minimum payments to the larger once, you end up paying ton of the interest as higher loans will have higher interest charges, and likely the higher rates then the smaller ones. You got the point? 10% percent of $2,000 credit card balance is $200. 10% of $10,000 credit card balance is $1,000. So go to the roots. And stay away from the bad debt. However easy it is to follow, the cost is high.

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