In Over Your Head—Life-Saving Strategies for Financial Crisis

Bulletin 891

Section 3: Self-directed repayment plans

• Self-discipline.
• A down-sized budget, with a plan for saving money for emergencies and unexpected expenses.
• Knowledge of a simple debt reduction technique known as "power payments."
• Taking on no new debt.

In addition to the priorities that you have established above, other factors may help you decide the order in which debts will be paid. To pay the least possible amount of interest, list debts in order of those with the highest interest rates to the one with the lowest rate. If it will be more satisfying and motivating for you to see debts paid and crossed off your list, then list them from the debt with the smallest dollar amount to the largest amount owed. Remember that you may pay more total interest paying debts in this order.

Here are steps to help you develop your repayment plan:

1. Stop all unnecessary spending. Necessary spending includes food, shelter and essential medical treatment. Discuss finances with your family and have each member develop a personal action plan to help keep expenses to a minimum.
2. If you have pre-authorized monthly direct payments or money transfers, examine them and choose the ones you need to continue. These might include mortgage, car and other loan payments and insurance premiums. Are there any that you should discontinue?
3. Complete the Know what you owe worksheet (pdf). This will combine all the information you need in one place.
4. Prioritize your debt. Decide which bills to pay first and which to delay until you can add to your income. Consider the consequences of not paying each debt. Could you lose your home, your car (if you need the car) or other possessions? Could your utilities be disconnected? You may consider the following priorities.

   High Priority: Housing, essential utilities, car loans or leases and necessary insurance (if you really need the car), child support, and taxes.

   Medium Priority: Loans with collateral (except household goods) and student loans.

   Low Priority: Loans for household goods, credit cards, doctor's bills, loans without collateral, rent-to-own contracts.

5. Down-size your budget to make money available for regular payments on your debts (use the budget on pages 17–18 (pdf)). How much do you need for basic living expenses? If you have never developed a written spending plan before, you will definitely need one now. There are resources available from your Extension office, as well as self-help books, computer software, and financial web sites to help you.
6. If you have money left, then you are well-prepared to go to the next step in developing a debt-repayment plan. If your basic expenses and your debt payments are more than your income, you are going to have to take some action before you can develop a plan to eliminate your debt.

   Contact creditors to see if some of your minimum monthly payments can be reduced. Creditors may be willing to accept a lower monthly payment if they know that it will be paid on a regular basis. Do not promise to make payments that you cannot afford. Know that you can follow through and honor the commitment you are making.

   Go over your down-sized budget and look for ways you could cut back on flexible or unnecessary expenses. Any amount of money that you are able to cut back can be used for debt repayment.

   Your budget plan should reflect the cutbacks and reduced minimum payments you have negotiated with creditors. Your expenses plus minimum payments on all your debt should be less than your income. If they are not, you should explore other options explained in this booklet.

Develop a spending plan to meet your minimum needs using the Down-sized monthly budget (pages 17–18 (pdf)):
1. Estimate your monthly take-home income. Include income other than earned income such as interest, dividends, pensions, child support, and alimony.
2. Estimate your fixed expenses. These are expenses that you must pay every month for basic needs, including rent or mortgage, utilities (only those you need), debt payments (include minimum payments on all debts), child support, alimony, car insurance and necessary medical expenses.
3. Calculate the amount you need to spend on necessary but flexible expenses each month. These include food, transportation, basic household operation, and essential personal allowances.
4. Estimate the necessary expenses that will arise occasionally during the next year. These might include vehicle license plates, minimum car maintenance and repairs, medical care, clothing for growing children, and basic school expenses. Total these expenses and divide the amount by 12 to determine how much money must be set aside each month to cover these necessary occasional costs.
5. Total the dollar amounts determined in steps b, c, and d. Subtract them from your income.
7. Develop a repayment plan using the concept of power payments. The total amount of money spent on debt repayment each month will remain the same until all debts are repaid.

   Pay the minimum payment on each bill each month.

   When the first debt is paid, add the minimum payment on that debt to the minimum payment on the second debt. Pay that total each month on the second debt until it is paid. Continue to make the minimum payments on the rest of the debts.

   When the second debt is paid, add the amount to the payment on the third debt. Pay minimum payments on the rest of the debts. Continue in this manner until the debt is eliminated.

   Remember that this repayment method assumes that you have stopped making purchases on credit.

8. Find extra money to add to your monthly debt payment. Your repayment plan will be more effective because the time to repay all your debts will be decreased you will save considerable money in interest.

   Identify an amount of money, above the minimum payments due, that can be applied each month to debt repayment. This money might come from cutting back spending, an extra job, overtime pay or reduced spending.

   Add the power payment to the minimum payment on the first debt. For example, if the minimum payment is $10 and the additional power payment is $25, pay $35 each month until the first debt is eliminated. Meanwhile, continue to make minimum payments on all other debts.

   Continue as outlined in Step 7 until all debts are paid.

9. Use lump sum payments from overtime pay, bonuses, income tax returns, a second job or gifts to decrease debts or pay a debt fully . They will further decrease repayment time and the total interest charges paid.
10. PowerPay© software was developed by Utah State University Cooperative Extension Service. This educational tool will calculate a personal repayment plan for you. It allows you to compare repayment plans that begin by first paying off the highest interest, the smallest balance or the shortest term debt. It shows the total interest costs and length of repayment time with and without the use of power payments. It can also incorporate a lump sum payment and show how this will affect the repayment time and total interest paid. Make an appointment with the Family and Consumer Sciences agent to use this program at your local Ohio State University Extension office. This service is completely confidential.

References

Miller, F. Dean and Judy L. Harris: Powerpay©, Version 4.0 for Windows®. Utah State University Cooperative Extension Service, Logan, Utah 84322-3050

Miller, F. Dean and Judy L. Harris: User's Guide: Powerpay© Version 3.0. Utah State University Cooperative Extension Service, Logan, Utah 84322-3050

Out of Hock, Holliston, Mass: Dahlstrom & Company, Inc. 1995