How to Dig Yourself Out of Debt and Save at the Same Time

Paying down debt can be a daunting task. But with a little self-discipline and some faith in yourself, your financial picture can change for the better in about six months.

The following three-part strategy may help you control your cash flow and encourage saving so you can pay off your debt and handle the unexpected expenses that may have gotten you into debt in the first place.

Step 1: Track Spending

Begin by tracking your typical income and expenses for one month. Also figure your unexpected expenses for a year's time -- auto and home repairs, gifts, vacations, etc. -- and divide that number by 12. Once you have a record of your spending, compare your monthly outlay with your monthly income. If you have a surplus, you can apply this amount to paying down debt and building savings. If you have a shortfall, you'll need to cut expenses.

Step 2: Build Savings

Next, you'll need to establish good saving habits. Each month, use your income to first pay expenses, then dedicate whatever is left to savings or reducing your debt. Here are some tips to get you started.

• Ask your bank to set up two savings accounts that are linked to your checking account. Label one "cushion" for emergency cash and the second, "investments."

• Whenever you're paid, put only what you need to live on into your checking account.

• Begin building your emergency savings by depositing a portion of each paycheck into your "cushion" savings account. If your goal is to have three months' living expenses, you could reach your goal in 30 months by saving 10% of each month's pay -- or in 15 months by saving 20%.

• Put whatever is left into your "investments" account, including found money such as birthday and holiday checks, annual raises, bonuses, etc.

• If you find it hard to control your spending when access to your savings is easy, ask your employer about direct deposit. You can have money taken from your paycheck and placed in a savings account automatically.

Step 3: Reduce Debt

The third step -- and the one people typically find most challenging -- is actually paying down their debt. But now that you are starting to get more control over your finances with steps one and two, you can get a better grasp of how much money is available to begin chipping away at debt. To get started:

• List your debts in order of interest rate, from highest to lowest.

• Add up your liquid assets, including savings and investment accounts, if any.

• List any major purchases needed in the next year. Subtract this amount from your liquid assets. What remains is the amount you may have to pay your debts.

Be smart and systematic about paying off your credit cards. Here are a few tips to help:

• Pay off your highest interest card debt first, making sure you avoid the "minimum balance trap." You can eliminate debt and save money by paying more than the minimum monthly amount on your credit cards. The table below shows the difference between making an assumed $20 minimum payment on a $1,000 debt versus paying $40 a month.

• Consolidate debt. Competition between credit card issuers is so intense that you can often negotiate your interest rate. Just be aware that some of the low rates quoted are "teaser rates," which only apply during the first 6 to 12 months you have the card.

• Cancel your old cards. The most you need is two. And leave them at home unless you really need them.

• Set up a realistic payment timetable and stick with it. If you need to readjust your timetable, do so. If you have trouble, talk to a professional. The counselors at the nonprofit National Foundation for Credit Counseling can develop a more structured plan for you, if needed. To find their nearest location, call 1-800-388-2227.