Live Debt-Free

In retrospect, it's clear that what started as a celebration morphed into quite a bender. According to the Commerce Department, Americans collectively spent more than we earned after taxes for the past two years in a row — the first time that's happened since the Great Depression. The household debt-to-income ratio has reached an all-time high, topping 19%. Meanwhile, many forecasters see rising inflation and interest rates ahead. Michael Hudson, president for the Institute for the Study of Long-term Economic Trends, sums things up pretty simply: "The free lunch is over."

That means that for many of us it's time for two aspirin, a splash of cold water and a new attitude toward personal finance. The new motto: The less debt you have, the happier — and wealthier — you'll be. And while even the caviar and Cristal crowd seldom live their whole lives without borrowing, keeping your debt load as light and as cheap as possible is the key to a more secure future and to guilt-free spending on the things you need and want.

It's a skill that's often neglected and seldom discussed, but understanding how to manage your debt will let you build wealth faster, and with less risk. Disciplined saving and smart investing are the topics that get the most ink — hey, we read this magazine too — but without a good debt strategy, the planning for your financial future can get awfully wobbly. The explanation comes down to Home Economics 101: Paying interest works against you in the same way that earning it works for you when you invest. The average household owes about $9,900 on credit cards at an annual rate of 15%, according to the research firm CardTrak.com, costing about $1,500 a year in interest. If a family invested that interest every year instead and earned 8%, after 30 years they would have an extra $181,700. With auto, college and even mortgage loans, the interest snowball is a little smaller because rates are lower, but you'd still much rather throw it than get hit by it.

If becoming debt-free can seem like a pipe dream, it's one that most of us share: A recent survey by the financial-services company LendingTree shows that 74% of Americans envision themselves debt-free, excluding mortgages, at some point in their lives, but only half said they have a plan for how to get there. Luckily, SmartMoney has one too — which focuses on carrying only as much debt as you need, keeping it cheap by snagging the lowest interest rates and getting to debt freedom sooner rather than later. We've even got a finish line for our plan: retirement. After all, once a person starts living off a nest egg rather than a salary, those interest payments hurt all that much more, forcing the retiree to live on less to stretch the savings. "The people who have the most trouble are the people who carry the most debt into their retirement years," says Charles Farrell, a financial adviser in Denver. "Those fixed obligations can bury you."

To be sure, some debt — especially a mortgage, for which the interest is usually tax-deductible — is a prudent fit in one's financial life, especially for younger people. But as any good thesaurus will tell you, debt is just another word for liability. In trying to cope with it, many people wind up foundering because they try to employ separate strategies for each of their burdens, attacking their credit cards, auto loans and other obligations as if they were unrelated enemies.

We think there's a better way to move toward a debt-free life: adopting approaches that can generally be applied to all debt. It means, for example, speeding up payments on just about every category of debt, from mortgages to school loans, and shifting to as many "fixed" loans as possible. Below, we'll outline strategies that can be used, together or in tandem, to tackle all kinds of obligations — in ways that can save hundreds of thousands of dollars over a lifetime.