It is important to try to improve your credit rating. Paying off debt on time should be seen as a vital part of keeping your financial affairs in order. Often, people will fail when trying to improve this rating because they think that taking out more credit or different types of credit will help. In reality, planning and budgeting are the key to improving your credit rating and many people find this a lot less appealing than taking out another credit card. However, the truth is that there is no substitute for paying your bills on time, and paying them off as quickly as possible.

Budgeting is the Key

Often people lose track of their finances because they’re not managing their money properly. Setting a simple monthly budget will shed light on the actual state of your finances and provide a guide on what you can or cannot afford.

Don’t make purchases on credit, even if you see an item that has been discounted and think that it’s a good bargain. If you put this on your credit card but do not pay the full balance when the bill arrives then, due to interest charges, the item will work out to be more expensive than you think.

Short and long term budgeting are crucial when trying to improve a credit score and get out of debt. Once you make these plans, you need to stick to these budgets and not deviate. Work out what your monthly income is and also your fixed monthly expenses. By doing this, you can calculate what your disposable monthly income will be. These short term measures can allow you to make longer term plans, such as saving up to pay cash for larger purchases such as vacations, Christmas gifts, or furniture. When you quit putting puchases on credit and pay down the debt you already have, your credit score will gradually improve.

Spending Money You Don’t Have?

Although the overall level of personal debt has gone down during 2010, many of us are still too careless with our credit cards. Spending money you do not have is extremely damaging to a credit rating. Credit cards allow people to spend money they do not have because a credit limit is set by a number, not actual money in the bank. People spend 15-20% more when using credit than when using cash, so it is best to pay with cash. Some people take out numerous credit cards and use one credit card to pay off debt on another one. For obvious reasons, this is not a smart thing to do.

Probably the most important thing you can do to improve a credit rating is to pay bills on time. Credit agencies will see it as a big black mark against you if fail to pay bills on time. This will have a very detrimental effect on your rating. If you only pay back the minimum amount required every month it can be difficult to pay off overall debt.

In short, improving your credit rating is a worthwhile goal. Budgeting and being aware of spending habits will help you get there.

At this point in our journey out of debt, my husband and I had paid off a couple of smaller debts and were pressing forward on the larger ones.  We came to realize that “pressing forward” often meant one step forward, two steps back, but we were determined to finish the job.

We had many reasons for wanting to get out of debt, but one of the greatest was my desire to be a Stay-at-Home Mom.  We needed both our incomes to make all our monthly payments, and that meant I had to keep working.  We had a great babysitter for Bub, but that wasn’t the same as being home with him myself.

On top of that, we wanted another child, but the thought of leaving a new baby with the babysitter was very. . .upsetting.  If we could pay off our debts, we could get by on my husband’s salary and my part-time job teaching online classes–and I would get to stay home with the kids.  That was an extremely powerful motivator.

I wanted another baby in the worst way. Bub wanted a baby brother in the worst way.  I can’t tell you how hard it was to hear him pray for God to send him a brother, knowing that one wouldn’t be coming any time soon.  All because of our STUPID DEBT!  I started to get mad at the bills (in a good way).  I saw them as thornbushes standing between me and my second child, and I wanted to hack them away as fast as possible.

So we kept hacking away.  Another bill paid off.  Then another.  Now the car payment was the only debt left. Unfortunately, it was also the largest.  But we kept on hacking.

What we really needed was a better tool to hack with. More on that next time.

Note: This is Part 4 of my “Get Out of Debt” Journey series. You can find the other posts in the series here.

My husband and I had finally gotten serious about getting out of debt and had been slowly making progress for several months. Although we faced the usual difficulties that come with living and breathing, we soon discovered that the biggest obstacle was ourselves. Our own enthusiasm and motivation were starting to fade, and we were getting a little sloppy about sticking to our budget. We needed a support system to keep us on track.

At the time, I was participating in an online forum that focused on credit cards and consumer debt. The folks on that message board gave me another set of accountability partners, in addition to our classmates in Financial Peace University (FPU). Having a support group is extremely important to anyone pursuing a long-term goal, whether it’s weight loss, getting out of debt, or getting a college education. The great thing about the online forum was that many of the posters were further along in the process than I was, so I got to seem them do a “victory dance” when they finally paid off that last bill. It was very motivating.

Sometimes I had to post messages to my online friends to psych myself up. Here is one post of mine from 2004 to show you what I mean:

“Before now, we’ve been making extra payments willy-nilly, then slacking off every time something came up. Problem is, something’s always gonna come up. But starting now, we’re getting lean and mean.

No more eating out every time we get tired. We’re putting $100 a month in an envelope for “blow money.” When it’s gone, no more fun and games until next month.

The Dodge Neon needs a new air conditioner. It will have to wait. I only drive five miles to work, and I can stand to be hot for ten minutes. Fixing it will be our reward once the other car is paid off.

The Ford Taurus could use some dent repair and a new paint job. Tough. It can wait until the credit card debt is all paid off.

No more using the Emergency Fund for non-emergencies. I have about $200 in my Paypal account that we can use for Christmas. Any other non-budget items will have to be negotiated at a family conference. According to the snowball calculator, we can be debt free (except the house) in about 18 months. Yippee! Now for the hard part–DOING IT!”

We had a couple of smaller bills that we were able to pay off within a few months. It felt so good that I took one “Paid in Full” receipt and hung it on the refrigerator for several weeks. It made me smile every time I looked at it.

But I also had a much bigger motivator to keep me going.  I’ll tell you about it next time.

Note: This is Part 3 of my “Get Out of Debt” Journey series. You can find the other posts in the series here.

At this point, we had our starter emergency fund ($1000) in place and were ready to tackle Baby Step #2 in our Dave Ramsey-style Total Money Makeover. We had figured out a budget that more or less worked for us, and were excited to have finally made some progress.

In FPU class, Chet and I learned about the Debt Snowball process. The idea is this: Make a list of all debts except the mortgage, smallest to largest. Throw as much money as possible at the smallest debt until it’s paid off, making only minimum payments on the others. Once the smallest debt is paid off, take the money you had been spending on that payment (plus any other money you can find) and attack the second debt. Repeat until all debts are paid off.

The idea is very simple, but very effective. It was extremely liberating to have a step-by-step plan to focus our energies, instead of spreading it out over several different goals. It helps you stay motivated and not get overwhelmed by a dozen different financial goals you “should” be pursuing. Instead of a dozen, we had ONE goal–one bill to pay off. All our extra time and money went toward that ONE tiny goal. When it was done, we moved on to the next one.

The process was simple in theory, but difficult in practice. For example, the air conditioner gave out in my car. Do we shell out $450 to replace it so I can be comfortable on my ten-minute commute to work, or leave it alone until we get some bills paid off?

We lived in a new house with no automatic garage door openers. Do we buy some, or keep paying off debt, grit our teeth and keep manually opening the doors for a while? In the past, I’d have been looking for low interest loans online, or charging up the credit cards. But this time I was determined things would be different.

When I came home from work tired and didn’t feel like cooking, should I dip into the debt snowball money for a nice restaurant meal, or just suck it up and cook something?

People often criticize Dave Ramsey for advising people to pay off smaller bills first instead of bills with the highest interest rate.  It doesn’t make sense until you follow a family through the process.  We need to feel those little wins, especially in the beginning.

The fact is, getting out of debt was a tough slog for over a year. We were working extra jobs and selling stuff, but not getting to “enjoy” the money. It all went to paying off bills, or at least that was the plan. Sometimes we messed up. Sometimes we gave in and blew money that had been budgeted for something else.

But we got back on the wagon and kept trying. I tried to find ways to get excited again when the initial “rush” started to face away. More about that next time.

To help fill in the some of these little-known gaps, I’m starting a series of posts about how my family actually did it. So without further ado, here is the first installment.

Part 1: How we started

The year was 2004. At the beginning of our journey out of debt, my family consisted of me, my husband Chet, and our three-year-old son “Bub.” We had approximately $25,000 in credit card, cash loans and car debt, and we weren’t happy about it. At the time, Chet and I were both working outside the home, and we were living paycheck to paycheck. We were extremely lucky not to face any serious emergencies at that time, because we had less than $500 in savings.

We weren’t poor. We had good jobs and a 2000 square foot house, but we had a negative net worth anyway. In other words, we were broke.

Credit card minimum payments and car payments ate up about $600 per month of our take home pay. By the time we paid our house payment, utilities, food, and insurance, we had little if anything left over (or so we thought. . .more about that later). Nothing to save for emergencies. Nothing to invest for retirement. No college fund for Bub.

Our paycheck-to-paycheck lifestyle also created an extreme amount of stress. We fought about stupid things like how much to spend on clothing (because we had no money set aside for that, DUH!), whether we could afford to eat out or not, and how much to spend on gifts for family members. An unexpected car repair or a flat tire felt like a bomb exploding and blowing our fragile situation to smithereens. Paying the copay for Bub’s ear tube surgery was a major ordeal that took months to pay off. Our lives might have looked happy on the outside, but the stress we felt was huge.

I began reading The Total Money Makeover by Dave Ramsey and found that many of the ideas made sense. Debt is not a tool, I learned; it’s an unfortunate circumstance that should be avoided. Some of the advice seemed rather shocking at the time. I don’t need to have a car payment? Life insurance is not a good investment? Credit Cards are not a great way to earn airline miles? Fascinating stuff.

Then our church started offering Financial Peace University, a course and support group developed by Dave Ramsey’s organization. Since we approved of Dave’s basic principles already, we figured it was worth trying out. We might learn some interesting tidbits and make new friends. . .and maybe even reduce our debt a bit.

When we arrived at our first class, we thought we were pretty serious about getting financially fit. Turns out, we had no idea what “serious” really meant.

Stay tuned!

Although some people swear they use credit cards as a budgeting tool and don’t overspend with them, I am NOT a big fan of credit cards in any form. Here are a few reasons why I don’t like them:

• Even if you pay them off every month, most people spend 15-20% more with a card than they do with cash.
• You might accidentally miss your due date and get hit with a nuclear bomb in the form of late fees and jacked-up interest rates.
• Even if you always pay on time, credit cards are very sneaky and will often play dirty tricks–like moving due dates, changing terms of service, or “losing” your check to get you to pay late fees or interest.

The only smart use I can see for credit cards, or other unsecured loans for that matter, is to use a balance transfer to lower your rates on credit card bills or car loans you already have. In that case, you aren’t borrowing any more money, just paying less interest on your existing debt. My family did several balance transfers when we were paying off debt, and it helped shorten our payoff time by several months. But if you do get a new credit card, please don’t make any new purchases with it! The object of this game is to pay it off as soon as possible, not dig yourself into a deeper hole.

Don’t get me wrong, people can and do use credit cards responsibly. But credit card companies are often sleazy and play games that I just don’t want to play. They can keep their airline miles and reward points as far as I’m concerned. I’d rather have peace of mind instead.

So here’s how to sell the upside-down car:

1) Read the fine print on the balance transfers to make sure you understand the interest rate and any applicable transfer fees. In most cases, paying a modest fee will be worthwhile to get rid of a monster car payment.

2) Use one Balance Transfer check or a combination of checks to pay off the car loan. Depending on which state you live in, you may have to wait a few weeks to get back the free-and-clear title to your car.

3) Sell the car. Do some research at http://www.kbb.com/ to set an appropriate price. You’ll usually get a better price placing a classified ad and selling to an individual rather than selling to a dealer.

4) Use some of the proceeds to buy a VERY CHEAP CAR. Again, buying from an individual is generally cheaper than buying from a dealer. In my opinion, the best buys are older, out-of-style cars with low mileage. Yes, they do exist if you’re willing to hunt for them–and swallow your pride. Of course, you’ll want to get an independent mechanic to check out the car first to make sure you’re not buying a lemon.

5) Use the rest of the proceeds to pay down the Credit Card balance. You’ll have some balance remaining, but that’s OK; you’re still less in debt than you were before.

6) Put the remaining debt in your overall payoff plan. Depending on the amount and the terms (is the rate for life, or does it expire) you may want to attack it first or wait until later.

Good luck!