Money Tool of the Month: Debt Reduction Worksheet

Absolutely critical to any attempt to reduce debt is to get a really clear picture of your current debt situation. The Debt Reduction Worksheet, created by Karen McCall (founder of the Financial Recovery Institute), is extremely valuable in not only getting clear, but in developing and carrying out a strategy to eliminate debt once and for all. I use this worksheet with all of my clients who are working to reduce and eliminate their debt; the example here is a simplified version of that worksheet.

The first step is to gather all of your bills for unsecured debt – that is, all the bills for your credit cards, store cards, student loans, personal (non-auto) loans, computer or furniture financing, and the like. Don’t worry for now about your car loans and your mortgage, they are both examples of secured loans, and also are likely to have significantly lower interest rates. The exception to this general rule might be if you are behind on a car loan or your mortgage; you might include it and note the amount overdue, which definitely should be taken into consideration in creating a debt reduction strategy.

Now take out a piece of paper and create 5 columns. In column 1, list all of the companies and people with whom you have outstanding loan balances. In column 2, list the current interest rate for each company or person. In column 3, enter the minimum monthly payment for each; in column 4, enter the current outstanding balance. I like to add a column 5, in which I enter the amount of interest charged on the most recent statement for each debt.

Now, take a deep breath, and let’s find out the total picture. Total the minimum monthly payments in column 3 to find out the total minimum dollars you need to pay each month just to stay current with the debt. If this number is less than 10% of your take home pay, you’re in fairly good shape, although I like to see no credit card or store debt at all. If the amount is over 20%, you definitely need to follow the seven steps in this month’s Feature Article; the more of your take-home pay you have committed to paying off prior purchases, the less flexibility you have in deciding where to spend your money each month, and the more difficult it is to save for your dreams and retirement.

Add the current outstanding balances in column 4 to find your total indebtedness (excluding mortgages or car loans). And then in column 5, total the interest charged to find out how much of the most recent payments went to interest; if you didn’t have this debt, this is money you could be spending on things to enhance your lifestyle, or saving to improve your financial security. If you subtract this from the total in column 3, you will know how much was actually used to reduce amount you owe; clients are often surprised by just how small this number is.

All of this information is necessary to implement the seven steps in the accompanying article; you'll be able to clearly see which debts have the highest interest rates and which have the highest and lowest balances. This information is critical in working to reduce interest rates and determine priorities in paying off the different accounts. Have this information in front of you when you use debt-reduction software (such as at Quicken.com); you can see how long it will take you to pay off the debt, using the minimum monthly payments with current interest rates, and by varying interest rates and varying payments on one or more of the accounts.

Once you’ve determined your debt reduction strategy, you can expand this worksheet to track your progress. Just add 12 more columns, one for each month in the next year, and then, in each month’s column, enter the new balance as you receive each statement. By adding up the new balances, you will have a new total to compare to where you started (the total of column 4).

You can create this worksheet on a ledger paper or, if you are familiar with spreadsheet software such as Microsoft Excel, you can create one in your PC and save yourself the calculations.

Logically, if you are not adding any new debt, and if your total monthly payment exceeds that month’s interest charges, your total debt will be going down each month. How fast it will go down depends on how much larger your payments are than the interest charges; you can increase this by reducing the interest rates, increasing the payments (if your spending plan allows), or both. If you do reduce your interest rates, you should change them on your worksheet to keep it current. I recommend that you do not, however, lower the minimum payments; as your outstanding balance goes down, so will the minimum payment stated on each bill you receive, but you should always try to pay the same minimum payment you started with (if not more) or it may take you 20 or more years to pay off some of your debts, especially those with high interest.

Use this tool with all of the seven steps to living debt-free, and you too can have a life, even as you are working to reduce your debts.

By Kim Corwin, CRFC, AFC, founder of New Leaf Financial Counseling