First thing on a Monday morning, the financial advisor picked up the phone and heard a client ask a simple question: “Can you help me? I need to decide which loan I should sign.” When he asked the client, who was worth several million dollars, what it was all about, the advisor was stunned to hear: “I just can’t make ends meet.” The two scheduled an appointment for the following Thursday at the client’s home.

On his way, the advisor pondered the nature of credit, which can be a powerful financial tool. But used carelessly, it can turn into an enemy akin to a drug habit. Although U.S. household debt decreased slightly in 2008, Americans still started 2009 collectively owing about $13.9 trillion.

If you are in over your head in debt, don’t lose hope.  There are ways to fix your
seemingly unfixable problem.  But the first step may be the most painful: reducing your living expenses.

Most people know they can divide up their budget into what they want and what they need.  Fewer dinners out, fewer visits to favorite coffee stands, and less spending on entertainment are all places to cut back.  You can also likely reduce your spending at the grocery store and get a cheaper mobile phone plan.  Spending less is a start but its just the first step on the road to recovery.

The advisor moved quickly to put a plan in action. Summoning the wife into the discussion, he said: “I want the two of you to cut back your spending in every way possible, starting immediately,” he said. “You have lived above your income for years, and now you have to live below it. I want you to be essentially out of debt within five years. It won’t be easy but you can do it. Are you game?”  

Once they agreed, the advisor promised to help them create a lean and mean budget and then outlined his suggested cure, which he called a “Debt Snowball Plan.” He told them that, just like consumer debt itself, a snowball starts with a handful and then gets progressively bigger.

The debt snowball plan calls for paying off the smallest debts first in a quick manner and then moving on to the bigger debts. Some advisors suggest paying off the highest interest rate debt first, but others think a snowball plan makes more sense as people see the immediate impact of reducing debt and are therefore more likely to make the plan work.   The advisor in this case pushed his clients hard using the snowball.

As you work to reduce to your debt there are a couple of key points to remember:

    *Check with your creditors and see if they will accept less than you owe.  Some credit cards will waive fees and interest if you agree to a payment plan or can pay off the balance immediately.

    *Create part of your budget for savings.  This should include money for large expenditures that come up a couple of times a year.

    *Don’t overlook he need for an emergency cash cushion equal to three months of take-home pay.  That’s less than ideal but will give you some degree of protection if disaster strikes.

Before long the clients decided to drive more sensible cars, take only modest vacations and put a spending freeze on art and entertaining. Within a year, they realized they really didn’t need their huge home and its $8,100 monthly mortgage payment.

At that point the advisor knew he had succeeded. “I just wish more of my clients could do this,” he said to himself as he picked up the phone to speak with another client who needed help.

Tom Cock is a financial educator for Merriman

Editors note:  This article is also published in the April 2009 edition of Horizon Air Magazine.