Almost every day, someone writes to me with intimate details about their debt situation. Some of them are pretty mild and can easily be taken care of with a little bit of elbow grease - others are horrifying and will take some very serious attention to manage.

In either situation, the principles for getting rid of that debt are much the same. Very similar tactics can be applied whether the debt is a $200 credit card balance or a mountain of $250,000 worth of various forms of debt.

Here are the twelve tactics I’ve used myself to conquer debt - and that I always recommend to others.

1. Know what you owe.
Many people in a painful debt situation are oblivious to the true amounts of their debts. They get bills, make the minimum payments, and try not to think about it.

That needs to stop. Right. Now.

Take the last bill you received for every debt you owe. Sit down with these statements and figure out exactly how much you owe in total on each one and how much interest you’re being charged. If you can’t find this information, call the company holding your debt and get it from them.

This is key. You need to stare the full problem in the face instead of hiding it from yourself. If you keep hiding it, you keep convincing yourself it’s not really a problem while those interest rates eat you alive. And they will. An average credit card with an 18.9% interest rate with a $1,000 balance on it over a year will cost you $189. Increase that balance and that timeframe and things get scary quick - a $10,000 balance on that card held over two years costs you $3,760. Compare that to what you make.

Sit down, look at the problem, and realize that it needs to be solved. That’s the first step.

2. Figure out a plan.
The first step for solving it is to figure out a plan - a debt repayment plan. I wrote in detail about building your own debt repayment plan in the past - the basic steps are pretty simple.

There are really two sensible methods to figuring out your debt repayment plan. The first one is the Dave Ramsey “snowball” method, where you list your debts with the smallest debt first and focus on paying them off in that order. This one has the psychological benefit of giving you a sense of success over debt much quicker - and then that positive rush will push you onwards to more debt repayment.

The other one is the one I prefer - the interest-based method. In this plan, you simply list all of your debts in order of interest rate, with the largest interest rate on top. This is mathematically the best route to go, but it doesn’t have quite the same psychological “push” that Ramsey’s plan has.

Either way, you not only need to know what all of your debts are, you need to figure out the relative priority of the debts. Once you know that, you have a plan - and now it’s time to execute that plan.

3. Get caught up.
The first step is to get caught up on your debt payments. If there are any debts you have where you’re late on your payments, just make the minimum payments on all of your debts until you’re caught up on all of the payments. Without at least some history of regular payments, it’s very hard to talk to creditors and have them sympathize with your cause and it’s impossible to have a strong credit rating (which helps you on your other bills).

If you’re behind on your bills, the first step is to get caught up. There are some great tactics down below for coming up with the money you need to catch up on these debts.

4. Negotiate.
If you’re fully caught up on your debts, try negotiation, especially with credit cards. Call them up (using the number on the back of your card) and flatly ask for a lower interest rate. Suggest to them that you’re considering moving the balance with a zero interest balance transfer offer. If the first person says no, escalate - ask to talk to a supervisor.

You won’t always have success with this method, but any success you do have will pay serious dividends for you. If you have a $10,000 balance and you get the interest rate reduced even 3%, that’s a savings of $300 a year. Applying that extra $300 a year back to the balance ($25 a month) can save you as much as $7,000 in reduced finance charges, according to the credit card repayment calculator.

5. Consolidate.
Another method is to actually combine your debts through consolidation. There are many options for consolidation - zero percent balance transfers on credit cards, student loan consolidations, home equity loans, and personal loans are among the most common.

The first thing you need to know is whether you have good credit. Check out your true free credit report at annualcreditreport.com (since freecreditreport.com is a rip off) and make sure everything is correct on there, and also make sure you have a strong payment history in terms of paying your bills on time. If you’ve done both, your credit should be solid.

Zero percent balance transfers are a solid way to consolidate your credit card debt and reduce those interest rates for a while. Most balance transfer offers retain that low rate for only a short period of time (eighteen months is common), so you should only transfer your highest interest stuff to it, not everything.

Another option is to hit your local credit union and see what options are available to you. Many times, if you’ve been paying your debts consistently and have solid credit, you can apply for a personal loan to help you whack through your outstanding debt. Often, personal loans have solid but not stellar interest rates - good enough to wipe out credit card debt and other consumer debt, but that’s about all.

If you own your own home, a home equity line of credit is yet another option. This is often a lower interest rate debt that you can use to consolidate almost everything that has a higher interest rate.

All of these options will change your debt repayment plan, causing some debts to move up and others to move down. Adjust accordingly so that you’re sure you’re tackling the right debt with your extra payments.

6. Get some inspiration.
Debt repayment is a long, slow process and without some sort of inspiration it can be very hard to keep it up over the long haul. My suggestion is to find some inspiration - something you can visualize and think about when you’re repaying your debts. Why are you doing this? The answer to that question should point you right towards your inspiration.

For me, my inspiration is and always has been my children - my son and, later, my daughter, too. They show me that there’s an awfully big future ahead. They show me that the choices I make now have a lot of ramifications down the road. They show me what unconditional love is - and that stuff is just waste in comparison to that.

I keep my credit card wrapped in a picture of them, just so I can remember this when I go to spend some money.

7. Don’t rack up more debt - have an emergency fund first.
Now that you’ve got a good debt repayment plan, everything’s in order, and you’re inspired and ready to go, it’s tempting to go full-out on debt repayment and knock those numbers down. There’s only one problem - what will you do if your car blows up tomorrow? What happens if you lose your job?

If you really want that debt to disappear, you need to protect yourself against these events first, at least a little. The way to do that is with an emergency fund - basically, cash sitting in a savings account somewhere to help you through those tough times.

I recommend having at least a month’s worth of living expenses in there before you start going hardcore with debt repayment. This money can be used for stuff like car repairs, unexpected big bills, and so forth - it keeps you from having to go back into debt when something like that comes along. It’s better to have even more than that - when your situation gets under control, you may want to pump up your emergency fund.

Make minimum payments on your debts at first and build up your emergency fund. I use ING Direct for that purpose - they’re my primary bank, but they let you set up multiple savings accounts with just a few clicks. Make one of them your emergency fund.

8. Automate your minimum payments.
Online bill pay is one of the most powerful tools we have for battling debt. Most banks now offer this amazing service, which basically cuts down on the time you have to spend paying bills - but has a few other perks as well. I know it’s become an essential part of my toolbox - ING Direct’s tools for online bill pay are great.

One big perk is the idea that you can schedule payments. Automatic scheduling of payments is a great way to make sure you’re never late with a bill again. Just schedule a certain amount to be paid each month well in advance of the bill’s due date. For those with variable amounts, like credit cards, use an amount that’s higher than the minimum payment, but not overly so.

Each month, then, you know that your minimum payments are covered. Your goal then is to make a big extra payment towards whichever debt you’re focusing on in your debt repayment plan, every single month. The next few tactics will help you do just that.

9. Trim away some fat.
Look at the ways you spend money each month and look for things you can easily trim. A great place to look are the monthly bills (can you trim whole services, like Netflix, or perhaps just pieces of services, like unlimited text messaging?) and also the things you do during your daily routine, like drinking a latte. Any time you can reduce or even eliminate the costs of any such routine-oriented thing, you’re doing well.

One nice place to start is with your energy costs. Installing a programmable thermostat or some LED or CFL lightbulbs can easily lower your home energy costs. Making your next car purchase a fuel-efficient one will lower you automobile energy costs.

The key here is when you’ve saved some money, don’t spend it. Instead, channel that amount into an extra debt payment each month. Let’s say you eliminate a $4 latte per week. That means your extra debt payment each month should go up $16. Cancelled that premium movie channel? Your extra debt payment should go up $15. Installed 25 CFLs? Your extra debt payment should go up about $10. These add up.

10. Snowflake.
Snowflaking is a brilliant little tactic I first heard about over at the Paid Twice blog. The idea is simple: whenever you have a little windfall or make a good frugal choice, immediately save it for an extra debt repayment. I found that one of those “extra” savings accounts at ING Direct works really well for this - whenever I save a little money or have a little windfall, I move that amount from my checking over to the “snowflaking” account. At the end of the month, I use that snowflaking account as an extra debt payment.

Here’s an example. Let’s say that I normally eat out for lunch three times a week, but one day I decide instead to just eat leftovers, eliminating one of those meals eaten out. I then immediately move the $8 cost of lunch from my checking account to my snowflaking account. Similarly, let’s say I find a $20 bill on the street. Instead of spending it on silly stuff, I go home and move $20 from my checking to my savings, then use the $20 for something worthwhile, like groceries. Recently, I found a coupon for 10% off a complete order at Target. We stocked up and saved about $24 - that money was snowflaked. At the end of the month, there’s $52 that I can add into my debt repayment to help knock out that debt.

11. Watch your progress.
Each month, it’s worth your while to take a tally of all of your debts and look at where things are. Over time, you’ll begin to see real progress. Many personal finance books recommend charting this progress - noting your debt total one month, then your debt total the next month, and so on - so that you can really watch the change.

Why do this? It’s a big psychological boost to see your debt heading in the right direction instead of in the wrong direction. At first, I even used a large progress bar to visualize it, going from $17,000 in credit card debt down to $0. Each month, as that balance went down, I filled in a portion of that bar. It felt good to do that - really good.

12. Don’t let up.
When your debt starts going down, it’s easy to start feeling like things are under control, and you’ll become tempted to throttle back on the savings. “I don’t need to make that extra debt payment - things are good now!” That’s a false belief - it’s that very belief that got you into trouble in the first place.

Remember, every time you feel that you don’t need to pay down your debt, you’re reverting to the mindset that got you in trouble to begin with. Keep that in mind, always, and don’t let up. Debt freedom is a wonderful state to be in.

Jenelle wrote in recently and described her way of using credit cards:

Unlike your advice to minimize your credit cards, I actually have eight open credit cards that I use all the time. These cards cover all of my purchases but each one has a particular bonus program that I can take specific advantage of. Twice a month, I just log onto the online service for each card and pay each one off in full.

In essence, Janelle is describing having a portfolio of credit cards, enabling you to use the one with a very high reward benefit with every purchase. In some ways, this plan does make a lot of sense, but there are some severe drawbacks as well. The trick is finding a routine that works for you. Let’s take a closer look.

My Would-Be “Credit Card Portfolio”
In order to figure out what this situation would look like for me, I went through all of my spending over the last month and figured out several general areas of spending, mostly based on where I spent the money. From there, I started looking for credit cards that specifically lined up with those areas.

Gas expenses (21% of spending) could be shaved big time if I focused exclusively on one gas station. For instance, the BP Card earns 5% cash back on all purchases at BP, so if you use that as your exclusive station, you’ve got an immediate 5% rebate on all of you gas spending.

Other automotive expenses (5% of spending) could be covered by the Discover Open Road card, which gives a 5% cash back bonus on all automotive expenses.

Online shopping (21% of spending) allows you to use something like the Amazon.com Visa, which gives you 3% in rebates for all purchases at Amazon.com, which works well for us since we buy bulk items there, among other things.

Department store shopping (14% of spending) almost always offers a decent rewards card for in-store shopping. Since we mostly shop at Target (a Super Target is the nearest department store to us), we can get a card there that gives us a 10% off coupon for an entire shopping trip for every $500 run through the card. If you shop there spending $100 every trip, saving up big purchases to spend $300 when you have a 10% off coupon (saving $30), that means you save $30 on every $500 in purchases, or about 6% back.

Grocery store shopping (29% of spending) and other purchases (11% of spending) would perhaps best be covered by the American Express Blue Cash card, which offers 1% cash back up to $6,500 worth of spending, then 5% cash back on all purchases after that. If you spent $12,000 on the card in a year (by running some of your bills through it, for example, and doing all of your grocery store shopping with it), for instance, you’d wind up with an effective rate of about 3% over the course of a year.

So let’s say I spent $1,500 a month through these cards at the percentages described. On the gas card, I would spend $315 and earn $15.75 in cash rebates. On the other automotive card, I’d spend $75 and earn $3.75 cash back. On the Amazon Visa, I’d spend $315 and earn $9.45 in rebates. With the Target Visa, I’d spend $210 and get $12.60 back. On the remaining card, I’d spend $600 and earn $18 back. All told, my returns would be $56.55 over that month on spending of $1,500 - that’s approaching a 4% return on the spending. For my life, at least, it would work pretty well, at least at first glance.

Dangers and Drawbacks
As with anything involving credit cards, there are a lot of dangers and drawbacks to this plan. As I said before when commenting on the credit card “holy wars”:

look at credit cards as being like a very dangerous power tool. If you’re careful and take the proper precautions, they can save you time and shower some rewards on you as well. On the other hand, if you use credit cards with reckless abandon, you run the serious risk of some intense financial damage to yourself.

Using this “credit card portfolio” idea amplifies the above statement. A 4% return across all of your spending is nice, but it’s fraught with complications and potential traps.

There’s more maintenance effort. Having several cards with active balances on them means more footwork. As Jenelle described, she puts in significant time just maintaining the cards, going through a session twice a month where she logs onto eight different online accounts. Not only that, you then have eight accounts sending you all sorts of stuff in the mail - and you do get stuff, even if you opt out. Even if this whole process only added up to an hour each month, it’d still only net me a little bit more than the straight 3% I get from my current card use - is that extra hour of online busywork worth $14 or so? It isn’t for me.

There’s a greater risk of identity theft. Using this plan means you have more open lines of credit, which means a slightly increased risk of identity theft. If you have several cards, after all, it’s easier to lose one and not notice it for a while. If you have several numbers out there, it’s easier for one of them to be nabbed.

One mistake undoes the benefits. If you’re late even once on just one of these cards, you’ll undo the benefits you gained. In other words, to excel beyond just using one or two cards, you have to be eternally vigilant.

Having a lot of credit cards can make it psychologically easier to buy unnecessary stuff. “But I can get 4% cash back if I buy it” is not a reason that should be ringing through your head when considering a purchase. Instead, ask yourself whether the purchase is really worthwhile at all - ignore any “benefit” from the card.

Having a lot of credit cards with low balances and high credit limits can be bad for your credit score. Sure, your debt-to-credit ratio is low, but 10% of your credit score involves the types of credit you have access to and use, and having a lot of revolving credit is not a good thing.

Overall, there are too many drawbacks to such a plan to make it worthwhile for me. I’m not going to invest the time or energy to do that much card-hopping and account maintenance to just get an extra percent back on my purchases. I’ll stick with my original simple plan, I think.

Jimmie wrote in with a good question over the weekend:

I’m going to buy a new car in several months and I’m trying to figure out how much down payment I should have. I’ve heard tons of different answers from different people. What’s your take?

My initial take was to give this an off-the-cuff response - “bigger is better when it comes to down payments” - but then I realized I’d be falling into the same trap of all of the others that gave Jimmie advice. It’s all about the assumptions.

So, let’s walk through a good number of these assumptions and, along the way, figure out a good method for figuring out how much a person should be saving for their car down payment.

Step 1: Get Your Credit Report
The absolute first step you should take when considering a loan is to get your credit report. You can get your credit report for free from the federal government - no strings attached - at AnnualCreditReport.com. I recommend avoiding freecreditreport.com because it requires “enrollment in Triple Advantage,” a credit monitoring service you probably don’t need. Using AnnualCreditReport.com, you can request a report from all three of the agencies - if you’ve never checked your report before, it’s worth it to get all three.

Once you’ve got your credit report(s), read through them and make sure you understand what they’re saying. A credit report is a list of all of the debts you currently owe, as well as all of the credit lines available to you (like credit cards with a zero balance). It also lists any debts that you haven’t paid over the last seven years, including late payments and so on.

Go through this report carefully. Take the time to identify anything on the report that’s false and make an effort to get it corrected by not only contacting the credit reporting agency, but also the company that claims the debt. Get these issues straightened out before you move on.

Why is this so important? Whenever you take out a loan, sign up for a credit card, or get insurance, the company that you’re dealing with takes a peek at this report, which is often summarized for them in the form of a credit score. A credit score is basically just a number that summarizes all of the information in your report - if your report is good, your credit score is high, but if your report is filled with red marks, your score is likely in the trash.

As a rule of thumb, if you have a long credit report (more than two different kinds of debt) and very few negative marks (like late payments), your credit is very good and you’re likely to get a low interest rate on your loan. If your credit report is short, or if you have a handful of dings (more than three, but none of them too severe), you’ll likely get a pretty high rate. If your credit report is trash - with lots of bills turned over to collection agencies and so on - you’ll either get a very bad interest rate on your loan or no loan at all.

There is no exact formula for how your report will affect your credit. Not only is the formula for calculating a credit score not public, but the methods a lender will use to translate that score into a loan aren’t public, either. The best you can do is know your credit report, make sure it’s as clean as possible, and know whether you can expect a good rate or a bad rate.

Here’s a basic explanation of how credit scores are calculated as well as some tips for improving your credit score.

Step 2: Define Exactly What You’re Buying
The next step is to know what you’re going to buy. Here are some questions to think about.

Are you buying used or new? Buying a new car maximizes the period that you’ll be able to own the car, but during the first few years of ownership, the value of a new car drops like a rock. Buying a used car reduces that period, but also doesn’t cost you in the form of those first few years of rapid depreciation.

The rule of thumb that I’ve always used is that all cars fall 20% in value each year, and a brand new car falls an additional 20% as soon as you drive it off the lot. This is a very rough rule of thumb, but it’s served me very well for getting a thumbnail estimate of the value of a car while looking at cars on the lot using the calculator on my cell phone.

What model are you buying? It’s also a good idea to know the model you’re looking for before you go shopping, or at least have two to three models in mind. This way, you can do the research in advance.

How do I “do the research”? First of all, know what you want for a car. Are you buying a sedan? A compact efficiency car? A SUV? A minivan? Then, hit the library and look through back issues of Consumer Reports and other car magazines to find out what the reviews of models in that general area are and what models are recommended. For example, if you’ve decided on buying a late model used minivan, you’d want to look at the reviews of minivans from three years back, as well as information on the reliability of those models. I generally trust Consumer Reports, but you may want to dig into more sources than that.

Once you know what you’re buying, figure out the value of that car. Use Kelley’s Blue Book to look up the value of the model and year you’re looking at so you have a good idea of what you’re saving for.

Step 3: Figure Out How Much Down Payment You Need
Now that you have all of this information, you’re ready to figure out how much down payment you really need. Follow this decision tree.

Is your credit bad? If it’s bad, you need the biggest down payment possible because you won’t get a good loan no matter what. If it’s good, keep going.

Are you buying new? If you’re buying new, you’ll need at least a 20% down payment on that car, and here’s why. Let’s say you go onto the lot with no down payment, pick out a brand new car, and drive it off the lot. The second you drive off the lot, your car depreciates about 20%. Now, you drive it around for a month and suddenly you lose your job - and you realize you need to sell this expensive new car. The best you’ll probably be able to get for the car is about 80% of the asking price, but if you’ve made no down payment, even selling the car right now will leave you with 20% of your loan unpaid and nothing to show for it. This is called being “upside down” in a car loan, and it’s something to avoid if you can.

On an older car, this effect still exists, but it’s much smaller. You’re in good shape if you can have at least a 10% down payment on that car, because a used car can usually be resold without a major depreciation loss.

What’s the actual best loan offer you can get? Before you go, stop by your local credit union and see what sort of rate they would be willing to give you on the car purchase. Show them your research, tell them what you’re looking for, and tell them you can pay 20% down. If that rate is high - more than, say, 7% - then you should keep saving for a bigger down payment.

The reason is that if the interest rate on the car loan is higher than the interest you’d earn managing the money yourself in savings accounts or investments, it’s not a good deal. According to my observations, the magic number is about 7% - if it’s above that, you’re better off socking away your money for a while longer.

Also, remember that what you have saved for a down payment isn’t necessarily what you have to pay. If you have 40% saved up and can get an astoundingly low interest rate with only paying 20%, you don’t have to cough up that extra 20% - keep it for your emergency fund or for saving for the next car you’ll have to buy.

Here’s what you should do, summed up in one sentence: Have at least a 20% down payment (unless you’re buying an old car, then 10% is the bare minimum), but if the interest rate is over 7%, save for a bigger down payment and wait until you absolutely need the car.

Personally, I believe strongly in avoiding debt and paying cash for everything, but that philosophy doesn’t often reflect the day-to-day reality of most people’s personal finances. So I offer this one little piece of advice: start saving now. Set up an online savings account and have it automatically pull in $20 a week or so from your checking account, and then don’t look at it until you need a new car. Lo and behold, your down payment will be sitting there waiting for you - and the bigger, the better.

About two years ago, I had almost $17,000 in credit card debt. That added up to about a third of my salary at the time, and the minimum payments were more than my rent. Most months, my paycheck was gone before I would even see it, swallowed up by credit card payments, a rent payment, utilities, insurance, a bundle of student loans, and two outstanding car loans.

My wife and my infant son and I lived in a little apartment together and we had every luxury item we could afford. We liked buying neat stuff - I owned two iPods and had multiple computer systems, we had an enormous DVD collection that practically filled our living room (with a lot of them still in the shrink-wrap, bought but never opened), and my wife had a taste for books. Lots of books.

When we first found out we were going to have a child, we decided that he would have the best of everything. We spent several hundred dollars on an amazing crib for him and bought almost everything one could possibly think of that a baby would want. We turned the tiny second bedroom in our apartment into a nursery and just poured out the money. We bought a top-of-the-line breast pumping machine, dozens of educational toys, and a mountain of clothes for the boy.

We just kept sinking and sinking and sinking into debt, but I just couldn’t bring myself to really think about it. It was so much easier to not think about it, to just keep doing the same things I was always doing. I’d go buy DVDs and books and such after work, eat out for lunch at expensive places, and just keep sinking slowly further and further into debt. I assumed that “future me” would just take care of it.

One day, I woke up and there was no money. I had less than a hundred dollars to my name, a mountain of unpaid bills in front of me, and no forthcoming paychecks. I knew in the back of my mind that such a day would come, but I didn’t know when it came that it would punch me in the gut quite so hard.

I was scared. I held my son for a long time. I cried. I talked to my wife about everything and we went carefully through the bills. I went to the library - not the bookstore, for once - and checked out a pile of books on money management, trying to figure out how I could get myself out of this mess this time. Two of them really stuck with me - Your Money or Your Life and The Total Money Makeover.

The one thing I realized above everything else? Fixing it wasn’t that hard. Sure, the problem can’t be solved in a day, but the solution is really, really easy. Want some tips to get started?

Enjoy the stuff you have instead of buying new stuff. If you’re tempted to buy something, look around the stuff you already have and try out one of those instead. If you’re going to go buy a new DVD, watch one on your shelf instead. Lusting for a flat panel? Go for that upgrade - but wait until the TV you already have doesn’t work. Want to buy clothes? How about doing a big closet cleaning and seeing if there’s anything you’ve forgotten about in there? Look at what you’ve got before you spend some more.

Lock up all of your credit cards. Don’t carry them with you for a while, but continue to live your normal life. You’ll find your habits being subtly changed by this - and better yet, you won’t be building up a balance on those cards. Try it for just a couple of weeks and see what happens.

Pick your debt that has the lowest principal left and make extra payments on it. If you do the two things above, you’ll notice some extra breathing room in your monthly spending. Take some of that and make extra payments on the debt you have with the lowest balance. Hopefully, you can pay it off fairly quickly - and you can feel the rush of a debt burden being lifted from your shoulders. If you like that feeling, move on to the next debt.

Eat at home more. Even if you just go home and prepare a prepackaged meal, it’s substantially cheaper than constantly eating out. Try to incorporate making some of your own food as well - see if you can come up with a used crock pot and then start using it by just dumping in some ingredients in the morning, turning it to simmer all day, and coming home to a delicious and frugal meal. I make roasts in mine all the time - just put in a roast, a seasoning packet, and some vegetables and my wife and I have three or four delicious meals waiting for us.

It’s not rocket science, just a bunch of small steps you can take. The hardest part is just having the courage to take that first step.

Why I Wrote This Post

A reader named “Jon” sent me an email earlier today that’s worth quoting:

I’ve also passed the Simple Dollar along to some co-workers who are struggling financially. What I find, however, is most who are struggling don’t want to look in the mirror, because they don’t want to see the changes that need to be made and then make them.

This email hit a real nerve with me. The people that Jon talks about in this email are the very people I want to reach the most. They’re sitting in the very situation I was in three years ago - slowly sinking, getting myself more and more in debt, and, most of all, not wanting to face it at all. It’s much easier to not face it, after all.

If this sounds like someone you know, please send them this post. Thank you.

Recently, I mentioned a Consumer Reports article that encouraged people to invest instead of paying ahead on their mortgage. It left me thinking quite a bit about debt repayment and how I should handle my mortgage.

Our situation My wife and I are planning on eliminating our student loans in the next year to a year and a half, leaving us with just our home mortgage as a debt. Our plan has been to eliminate that debt as a top priority, probably via double payments on the mortgage - our plan is to be debt free by the time our son has his thirteenth birthday and then build a home in the countryside.

What double payments on a mortgage does On a thirty year mortgage of any size, making double payments each step of the way reduces the payoff date from thirty years down the road to nine years and two months down the road. It truly does make that kind of impact.

The best way to look at it is to look at your advance mortgage payments as an investment with a certain rate of return - a rate equal to the interest level on your mortgage. So, if you have a mortgage at 5.75%, an advance payment on that mortgage is basically an investment of that money at a 5.75% annual return. Most importantly, though, one should look at these returns as being after taxes (because, for most people, there isn’t enough interest there to create a huge benefit for itemizing versus taking the standard deduction).

Obviously, to beat this we would want an investment that could reliably return more than 5.75% after taxes per year over a ten year period. If you look at the returns on various index funds, like the Vanguard 500, you’ll see that since their inception, they’ve seen returns of over 12% on average. If that would persist over the next decade, one would definitely be better off putting their cash in such an investment than in the 5.75% mortgage.

The other factors This argument would seem to lend itself towards investing the money, then withdrawing it to pay off our mortgage in one swoop when the time comes. However, it doesn’t take into account several other factors that are worth looking at.

The variability of the market Past performance is never an indication of future returns. You can never just assume the stock market will do what you want. The next ten years could be utterly painful on Wall Street, or we could see another economic boom. My personal feeling is that 2008 will be rough, but the election of a new president will bring about a mini-boom, but even I take that with a grain of salt. The variability of stocks is a risk - is it a risk worth taking?

Flexibility With the money in a taxable investment account, it is accessible if I ever need it. If I prepay on the mortgage, the only way that money is accessible is if I take out a home equity line of credit. Let’s say I wish to buy a car. By having the money in the account, I have the flexibility to just pay cash for the car or to take out a loan on it, whichever makes more financial sense. It also serves as a giant emergency fund in the event of job loss or something else disastrous.

Willpower This is a lesser concern, but still significant. Having a significant amount of money just sitting there in an investment brings forth a desire to spend it. Do I have the willpower to resist it? I believe I do, but that doesn’t mean that when I have $50K sitting in an investment account I might not feel differently.

My conclusion The higher your mortgage interest rate is, the better it is to pay in advance instead of investing it. Where’s the cutoff line? It depends on a lot of things, but the big one is your risk tolerance - if you’re fine with a chance for a down market in exchange for a very good chance of being able to pay things off earlier, then it’s probably for you. Prepaying on your mortgage is very steady and reliable, but investing gives you the chance to hit a real home run and become debt free earlier than you thought possible.

For us, this possibility plus the liquidity of the money if we needed it has convinced us to put our money into an investment account instead of prepaying our mortgage, something we’ll likely begin to do by the end of the year.

One common tactic adopted by people who are in severe financial straits is an all-cash lifestyle. They tear up all of their credit cards and move strictly to a cash-based personal finance plan, cashing each check and living strictly off of that money.

I personally feel that this is a good immediate response to the revelation that you’re in serious trouble with your personal debt. It forces you, in a very dramatic and obvious way, to become more responsible with your day to day money management - there are only so many $20 bills to go around, after all.

In fact, for a few months after my financial meltdown, I used this very technique myself. I actually used the “envelopes” technique, where you literally place the money for each piece of your budget into a specific envelope just for that purpose, and then took money out of that envelope when you needed to spend it.

After a few months of this, I came to loathe the process. It was inconvenient, clunky, and made for significant work for me personally. Gradually, I moved back to the convenience of plastic, and I’ve been fine with it ever since.

What I finally came to realize is that if I couldn’t maintain any financial self-control with a credit card in my pocket, I really didn’t have the debt problem fixed after all. Consumer debt and unnecessary spending is an addiction, and if I didn’t have the willpower to go through a normal week without falling into the trap of poor spending choices, then I really hadn’t made the appropriate mental leap yet.

The cash-based system is like training wheels on the bicycle of sound money management. You can’t speed along and move efficiently with training wheels, but they make it very hard to fall off while you’re learning to properly balance yourself. Eventually, though, you take off those training wheels and ride like an expert.

I’ll be the first person to advocate trying a cash-based system for a few months. In fact, if you’re struggling with controlling bad spending habits, I really recommend trying it out. Just do everything in cash for a few months and watch your money supply tangibly dry up and replenish itself over time. You’ll start to see the connection between the paycheck and the spending in a way that you didn’t see before and it can be very valuable.

After a certain point, though, it’s time to take the training wheels off and see if you can ride responsibly and safely on your own. This means that you allow yourself to try using all of the financial tools at your disposal - and this includes the convenience and buying protections of credit cards - but use them in a safe and responsible manner.

You’ll know when the spend less than you earn mantra has really become a part of your life. It’s when you recognize that even though you can easily buy something, you’re better off if you don’t. It’s when you walk out of the store, credit card still firmly in your pocket, and into the fresh air of financial freedom.

This week, The Simple Dollar attempts to address challenging questions in personal finance by looking at both sides of the story and figuring out some of the factors you need to look at to make a decision.

Most homeowners are in the process of paying off a large mortgage, one which requires a large payment each month, and the majority of those mortgages are at a fairly low fixed interest rate (yes, regardless of the hullabaloo about subprime mortgages, the majority of mortgages are fixed-rate long term ones). Often people earn substantially more than they once did and can either begin investing the money or begin making extra payments towards their mortgage.

Which is the right path? This isn’t just a question of numbers, but also a question of goals and philosophy. Let’s take a look at both sides of the equation.

Debt Freedom!

Debt freedom is a spectacular feeling. Suddenly, you’re no longer encumbered with a large mortgage payment each month and your monthly budget suddenly shrinks greatly. Many more lifestyle opportunities open up to you - you can switch to a lower-paying but more fulfilling job, or perhaps even make the leap and become self-employed.

Paying ahead on your mortgage isn’t just a monetary investment - it’s a psychological investment, too. Watching that balance falling brings about a sense of purpose and a sense of peace - your monthly financial burdens are slowly disappearing and soon you’ll be free of the burden of your mortgage.

Even if you look at it strictly as an investment, it’s not too bad. If you have a 6% home mortgage, payments towards that mortgage will earn 6% - guaranteed. No worrying about ups and downs in the stock market, no worrying about anything else - a guaranteed 6% return, which you’ll effectively receive when your mortgage is paid off.

Invest For Your Dreams!

It’s a simple comparison. Over the last thirty years, the Vanguard 500 index fund has returned, on average, over 12% per year. A home mortgage is thirty years long. Thus, unless your home mortgage is 12% or close to it, you’re better off dumping your excess cash into that index fund.

That’s not to say that there won’t be individual years where putting money in the home mortgage won’t be a better investment - there sure will be. But a long-term commitment to investing instead of paying off a low-interest debt will give you more money (provided, of course, the next thirty years of the S&P 500 grow like the last thirty).

We’re not looking at a short term window here - if you’re looking at just a few years, the debt repayment is probably a better investment because of the volatility of stocks. But if you’re looking to be cash ahead many years down the road, money in the Vanguard 500 - or a similar broad-based low cost index fund - will come out on top of money in the mortgage every time.

My Take

To me, this debate comes down to goals. What are your goals? If your goals don’t require a large bankroll - for example, if you dream of being self-employed or only working part time so you can be involved with volunteer work - you can likely achieve them much sooner by putting money into the mortgage than into an investment vehicle. However, if your dreams center around expensive items, like a large dream home or grand vacations or similar things, you’re probably better off in the investment vehicle.

For our situation, a direct route to debt freedom is the better choice for now. We’re looking at the strong possibility of another child, and if we choose to do that, one of us will likely become a stay-at-home parent. That means that eliminating debt now means lower monthly bills when that time comes, making the financial situation that much more tenable.

One strong undercurrent of sentiment among commenters on this blog is that living a financially sensible lifestyle - spending far less than you earn, investing, not spending money foolishly, and so on - is boring. Incredibly boring, in fact. So boring that I get numerous comments along the lines of “WHY DON’T YOU GET A LIFE?”

Well, the truth is that it’s not really boring at all and, in fact, I feel substantially more fulfilled after turning my financial situation around than I ever did before. Here are seven tips that I encourage you to try out if you’re trying out financially sensible living and finding it to be less exciting than you’d like.

Re-evaluate your hobbies There are a lot of enjoyable hobbies out there that don’t require a fistful of cash. Read a book. Start a garden. Take a walk. Fully enjoy the DVDs/video games/CDs you already have. Teach yourself to cook. Then, focus on that hobby and really develop it - if you put in the time at any hobby, you will become more skilled at it. Since figuring out my financial situation, I’ve come to really enjoy cooking, something I didn’t enjoy nearly as much until I decided to actually learn how to do it with some modicum of skill. Not only is it fun, virtually everything I make is cheaper than eating out.

Involve other people Being frugal doesn’t mean being a hermit. In fact, it’s quite often worthwhile to get others involved. Invite friends over and prepare a meal for them. Have a movie night where you watch some of your favorites from your collection. Don’t shy away from other people out of some kind of “shame” that you’re being frugal; instead, put your lifestyle choices out there.

Go green Almost every environmentally friendly choice you make is also a frugal choice. Start recycling aluminum cans by having a separate storage container for them - and then take them to the recycling center yourself on occasion and make a few bucks. Reduce your energy use around the home and save on your electric and natural gas bills. Find ways to increase your car’s gas mileage and save on your gasoline bills. There are countless things you can do under the umbrella of going green that don’t involve spending money, plus it’s something you can discuss with others in a culturally relevant manner (while padding your pocket with the savings).

Buy things for the long haul Financially sensible doesn’t mean cheap - in fact, I quite often buy very expensive things. The only caveat is that these purchases were made with reliability and the long haul in mind. I am quite willing to spend a lot up front for a reliable and energy efficient appliance. In other words, you don’t have to fill your house with cheap stuff to be “frugal” - I certainly don’t and I don’t recommend it either. Instead, buy just the stuff you need - but buy quality. If you’re concerned about appearances, most of the best choices for total cost of ownership are aesthetically pleasing, too - they’re usually rather expensive right off the bat, but they’re cheaper over time and last longer because of reduced energy and maintenance.

Instead of buying ten frivolous items a month, focus on one quality item a month. A lot of people like to shop, and as a result they wind up buying a lot of stuff that’s completely unnecessary. To those folks, I generally recommend reducing but not eliminating your purchases. Instead of buying ten unnecessary things a month, cut that down to one, but make that item quality, allowing yourself to spend more than usual on that one item. This works particularly well for clothes shopping - I know one person who is addicted to buying shoes, buying several pairs a year, but I know she would get much more enjoyment out of one great pair of shoes than box after box of cheap pairs that are just worn a few times each.

Fill your life with positive reminders of your choices. I like visual debt reminders; they perk me up quite often and make me realize that the choices I’m making really are transforming my life. Keeping one in my wallet has convinced me to keep my wallet closed many times - and feel really good about it.

Give it time. Behavioral changes don’t come overnight. Spend some time trying out all of the other tips and slowly you’ll find yourself weaned from at least some of your financially irresponsible behavior. Once you’ve done that, it becomes much easier to start getting a grip on your situation and getting financially ahead.