Your child’s tuition is three weeks overdue and you’re dreading another phone call from the school office. It’s not that you planned to be delinquent, but the front end of your car finally gave way last month, and all your money had to be channelled into emergency repairs. Desperately looking for an answer, you notice a newspaper advertisement for a payroll loan.

Convinced that this may be the answer to your problem, you call the financial company to get more details on the loan. You realise that you can access enough funds to not only pay the outstanding school fee, but to clear off your credit card and repay your cousin the money you borrowed eight months ago. In fact, you decide that you might as well take the opportunity to finally replace your worn living room sofa.

Does this scenario sound painfully familiar? If so, you’re not alone. For many cash-strapped consumers, borrowing money to finance budget shortfalls is standard operating procedure.

Indebtedness On The Increase

There is an alarming rise in the number of people who are choosing to turn to loans to bail themselves out of financial jams. However, running out of money to pay your bills is one of the worst possible reasons to get into debt. While a ‘quick-fix’ loan may temporarily ease your cash flow challenge, you’re creating a cycle that will only bring increased financial hardships.

As you have to pay back the loan with interest, borrowing will only increase your monthly obligations. In addition, redirecting your income into repaying debt will prevent you from saving towards important goals such as building an emergency fund, buying your own home or investing towards a retirement nest egg. Don’t hand over your future wealth to a loan company!

Need help with getting out of debt? CLICK HERE!

From experience, I know that trying to become debt-free is one of the most difficult aspects of money management, as it takes tremendous effort, discipline and sacrifice. Here is an action plan to help you to dig your way out of debt:

1. Assess Your Total Debt

Many people are so depressed about their unmanageable debt that they refuse to open their overdue bills or communicate with the lending agencies. You must first gather up your courage and find out your true state of affairs. Examine your bank statements or call the loan institutions to get the current loan figures. You will need to know details on the monthly repayments, total balances, time left to repay and the interest rates.

If you have multiple loans, capture all this information on the debt tracker form available under the financial tools section of www.financiallysmartonline.com. You should also include information on any collateral backing your loans. This will help you to keep track of your overall debt position on one sheet of paper.

2. Find Extra Funds To Pay Down Debt

Many people are crippled by debt because the monthly repayments are difficult to meet. Use your budget to manage your spending and ensure that your loans are paid consistently. Where possible, try to cut discretionary expenses such as entertainment or eating out, and use these funds as additional payments to reduce your loan balances.

Another option is to liquidate assets or sell your belongings. If your loan is secured by collateral such as a bank account or land, it might be necessary to sacrifice the resource in order to get rid of the monthly debt burden. Remember that you can always recreate wealth over time. Also look to raising cash by having a garage sale or letting go of valuable possessions.

3. Create A Debt-Reduction Strategy

If you have multiple loans, then you could try to consolidate all your bills to obtain a more affordable repayment amount over a longer period. While debt consolidation may seem to be a good solution, be cautious about the assets you use as loan collateral. Several loan agencies are promoting home equity loans to consolidate debt, but in these uncertain times it can be dangerous to risk your property in this way.

If none of the previous options are possible then you will have to pay off your loans one at a time. Use the debt tracker to sort your debt according to the size of the loan balances, with the smallest one first. If you have two loans with similar sizes, rank the one with the higher interest rate first.

While paying at least the minimum required on each loan, concentrate on paying off the debt with the smallest balance as quickly as possible. When that loan is repaid, apply the former monthly payment amount to the debt that is next in the ranking. You will speed up your debt reduction by being disciplined in using this strategy until all the loans are paid.

So for 2010, change your appetite for debt and strive to live within your means. However, it can be difficult to stay out of debt if your income is not enough to meet your needs. Next week we will provide the solution for this problem.

Copyright © 2010 Cherryl Hanson Simpson. No reproduction without written consent.

Originally published in The Daily Observer, January 21, 2010