Mellody's Math: Getting Out of Debt

Oct. 21, 2002 -- Kathy and Jim from Texas face the same issues as many other American families — they are overwhelmed by credit-card debt, confused about their savings and spending priorities, and concerned they will never be able to retire or pay for their children's college education.

With three teenage children and retirement looming, their financial situation is desperate. Kathy, 53, and Jim, 59, have a combined income of $130,000 per year but are drowning in debt.

They are eager to reduce their debt, possibly buy a home and send their children to college. The couple must clean up their finances and to prioritize their financial goals.

The segment can be broken down into three main parts: credit cards, home ownership and college.

Credit Cards

The first goal should be to pay off the $70,000 in credit-card debt:

1. Talk the rate down Call your credit-card company and work with it to secure a lower APR (they are currently paying 22 percent on one card).

With a $70,000 balance, paying the minimum, at an APR of 22 percent, it would take more than 70 years to pay off and in that time, you would pay $191,714.15 in interest.

With the same $70,000 balance, and an APR of 18 percent, it would take 48 years to pay off and you would pay $104,615.29 in interest — a financial savings of $87,099 and a time savings of 22 years.

2. Cut 'em up and cancel!

Take out a scissors and cut up your five credit cards. In addition, absolutely resist any store offers to enroll in a credit card or charge card for instant savings. For example, they recently purchased a new computer at CompUSA with a CompUSA credit card.

You can not negotiate with a credit-card company after you cancel the account, so make sure you speak to them about the possibility of lowering your APR BEFORE you cut up your plastic.

3. Pay more than the minimumIf the Kathy and Jim choose to pay off their $70,000 credit-card debt by paying only the traditional minimum, it would take them almost 48 years in which they would pay $105,000 in interest alone (assuming an APR of 18 percent). However, if the couple could pay $2,500 a month toward their credit-card debt, it would take them only three years and they would save more than $83,000 in interest.