Debt is a nemesis to many, as evidenced by the fact that America’s total debt tops $21 trillion with roughly $4 trillion allocated to consumer debt. According to Experian, average credit card debt is $4,613 for the Silent Generation (1928-1945), $7,550 for the Baby Boomers (1946-1964), $7750 for the Gen X Generation (1965-1980), $4,315 for the Millennials (1981-1996) and $2,047 for the Post-Millennials (1997-2012). This is the type of debt that tends to swallow consumers up whole. That’s not to say that other debt such as mortgage debt and debt associated with auto loans, private loans, and student loans can’t drag you down kicking and screaming.
Regardless of which kind of debt has your head reeling and your financial goals beaten and bruised, the time to act is now. Every day you don’t work towards paying down your debt is another day you are digging yourself deeper in a hole and missing opportunities to improve your life and your health. Did you know the stress debt causes has been linked to anxiety, depression and panic attacks? Who needs that?! Debt can also hurt your credit score thereby limiting your chances for good rates, not to mention the amount of interest you will end up paying over the long-term.
The first step to claiming your financial freedom lies in seeing the big picture. You need to know what your total debt owed is. Jot down the balance owed on each debt along with the corresponding interest rate and monthly payment. Begin prioritizing which debts you’d like to pay off first. Write down your goals somewhere you can visually see them every day.
Many people use a combination of strategies in determining which debts to pay off first. Consider the following strategies in designing your debt paydown plan:
Pay off High-Interest Debts First
Obviously, the debts that carry the highest interest rate are hurting you the most and costing you the most money over time.
For example, say you owe $750 and you only make minimum payments until the card is paid off. Your DPR is 0.04% (based on an APR of 14.6%). Your minimum monthly payment would be $30, and it would take you 54 months to pay the balance. The total you would pay in payments would be $1,739, and $988 would be solely interest. The lower the rate, the less interest you will be paying.
Make More Frequent Payments
Pay your credit card bill every two weeks instead of every month. Doing this lowers your principal balance and saves you in interest. This schedule equates to 26 payments per year, which helps to reduce your principal balance.
If you receive a bonus or income tax refund, you can make a lump-sum payment since there are no prepayment penalties to pay off credit card debt. This will pay the principal down even faster!
Use the Snowball Approach
This is where you would pay off your smallest debts first, while making minimum payments on the other debts so you feel a sense of accomplishment, which provides further momentum in your debt paydown efforts.
For example, perhaps you have a $200 credit card, $500 credit card, $4,000 credit card, and $15,000 car loan. If you paid off the two smallest first, you would only be left with two debt obligations. Now that you have paid off the smaller two, you can apply whatever payments you had been making to those debts to the next one in line.
Use the Debt Avalanche Method
This method involves making minimum payments on all debt, then using any remaining funds to pay off the debt with the highest interest rate. Nerd wallet has a good article on this method along with a debt avalanche calculator.
If you have several debts that are becoming difficult to manage, home equity loans have been used to roll multiple debts into one at a reasonably low-interest rate. The lower rates combined with the deductible interest make this a favorable option for many. However, keep in mind this tactic reduces your home equity and essentially puts your home at risk, so only consider this if you have intentions of paying off the home equity loan over time.
Negotiate Rates or Balance Transfer
The only way to reduce your rate on your mortgage is to refinance. Whether it makes sense to refinance will depend upon your specific financial situation and certain factors such as how long you intend to stay in that house, the spread between your current rate and the potential new rate, total refinance costs, etc. There are several calculators available to assist you in making this determination.
As for credit cards, you just simply need to call and ask. Oftentimes, that is all it takes to get a lower rate. If they won’t lower the rate, or you see a better offer elsewhere, you can investigate doing a balance transfer. By doing this, you can transfer a significant amount of your balanced owed to a new card that is offering a low initial rate (sometimes 0%). This low rate is typically in place for anywhere between 6 and 28 months. After this time period, standard rates will apply. Be sure to do your homework so you know what the standard rate will be. Most balance-transfer cards charge a balance transfer fee as well, which tends to be between 3% – 5% of the total amount you are transferring over.
There are other more obvious ways to tackle debt such as limiting your spending, being more vigilant about saving, taking on a side job to earn extra income or selling your unwanted stuff. No matter which method(s) you decide to employ, the most important part is that you are taking a step forward in improving your financial life and overall well-being and that you are edging closer and closer to financial freedom.
If you have questions relating to debt paydown strategies, please reach out to us at (410) 824-1853.
Sources: Forbes/ Smart Asset/ Motley Fool/Kiplinger
© Geier Asset Management, Inc. December 2019. Dan Mules, CPA is a Client Manager and Tax Planning Professional for Geier Asset Management, Inc., a Registered Investment Advisor. The articles & opinions expressed in this material were gathered from a variety of sources, but are reviewed by Geier Asset Management, Inc. prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of December 2019 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual circumstances. In all cases, please contact your investment professional before making any investment choices. Geier Asset Management, Inc. is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.