3 Ways to Pay Off Your Debt the Right Way

Source: Flickr user Sean MacEntee.

Americans are starting to take on debt again: According to the Federal Reserve, the amount of money Americans owe in credit cards and other revolving debt had climbed 3.3% year over year to $882.1 billion as of November.

As a result, many Americans' debt levels are climbing more quickly than income, which grew by an average 1.7% in the 12-month period ending in November. If that trend continues to play out, an increasing number of people will struggle to pay bills and set aside money for retirement. In order to avoid becoming one of them, consider making these four moves to pay off your debt.

1. Increase your monthly paymentLenders make their money by loaning you money once and then capturing the interest payments you make. But the more you pay each month, the less you'll pay in interest -- and the sooner you can start lining your own pockets, instead of your lender's.

The minimum payment on a credit card typically represents just 2% to 3% of a borrower's outstanding balance. Paying the absolute minimum means it could take years to pay off the amount owed, particularlyif the credit card has a high interest rate. That's good forthe lender, but it's a pretty raw deal for borrowers.

Rather than making that low monthly minimum payment, commit to doubling it. If you can't double it, commit to paying something more every month. If you do, you'll not only reduce the amount of time it takes to pay off the amount you owe, but you could also save thousands of dollars in interest charges.

2. Reduce interest payments with balance transfersIf you're in over your head in debt, you might not be able to transfer balances from high-interest-rate cards to low-interest-rate cards. But a goodcredit score could enable you to take advantage of this debt-reducing move.

On the surface, moving debt from one lender to another might seem more like a shell game than a debt-reduction strategy. However, a good portion of the debt that accumulates every month comes from interest, rather than purchases. Thus shifting debt from a high-interest card to a low-interest card can save consumers hundreds of dollars per year.

For example, let's say you have a $10,000 balance on a credit card that charges 10% annually in interest. As a result, your outstanding balance is increasing by $1,000 per year in interest alone. If you transfer that $10,000 to another card using a 0% balance-transfer offer, you immediately reduce your expenses for the following year by that $1,000. Most balance transfers charge a 3% to 4% fee on the amount transferred, but even including that, charge you'd still be $600 to $700 ahead of the game, and those savings can be used to make additional payments that could save you even more.

Source: Flickr user Alan Cleaver.

3. Consolidate debt to a tax-deductible mortgageShifting credit card debt or auto loan debt to a home equity line of credit was a pretty common strategy before the housing bubble bust. Now that home prices are bouncing back, it might be worth considering again.

The interest charged by most lenders on home equity lines or mortgages is far smaller than the interest charged on credit cards and personal loans. According to Bankrate, the average home equity line of credit interest rate is currently 4.73%. If you qualify, then shifting that 10% interest, $10,000 credit card balance to a home equity line could save you more than $500 per year. But the savings might actually be greater, because mortgage interest is tax-deductible. That means the $473 paid in interest on that $10,000 transferred balance can reduce your tax bill. Over a number of years, those savings could add up nicely.

One more thingThe peace of mind provided from living debt-free can only be achieved, however, if spending is kept in check. That means borrowers eager to pay down their debt should not just embrace these suggestions, but should also pull their credit cards out of their wallets and lock them away.

As each credit card is paid off, avoid the temptation to call the lender and close that account. Keeping a zero-balance credit card open can increase your credit score by lowering your utilization rate. The improving credit score, in turn, could enable you to qualify for additional low-rate balance transfers that could help you reduce your debt even more.

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