Think of all the things you would do if you were debt-free. Would you take a tour of Italy, tasting all of the pasta dishes you can handle, sampling the Chianti in Tuscany and basking in the beauty of the Sistine Chapel? Perhaps you’d build up college funds for your children, buy a motor boat for summers on the lake, purchase a nice gift for a loved one, or, the most practical, build up an emergency fund. The possibilities are endless when the weight of debt is lifted.
In February of this year, the Federal Reserve reported that consumer debt exceeded $4 trillion for the first time. Total credit card debt is also at its highest ever, at $1 trillion, and the average American has a credit card balance of $4,293. Student loan debt has tripled in the last decade, now reaching $1.5 trillion, making a college education the second largest expense, after buying a home, that someone will incur in a lifetime.
Before diving in to how you can manage your debt, let’s talk about the two basic types of debt. Installment debt, like a mortgage, car loan or school loan, consists of a fixed total amount that you make payments toward until your balance is zero. Revolving debt, or credit card debt, has a balance that fluctuates month by month, depending on spending and repayment habits. Neither type of debt is “good” or “bad”, but how you handle that debt determines whether it will help you or cause problems. Here are a few suggestions on how to plan for and manage your debt.
1. Make a budget
This seems pretty obvious, right? Before you take on any debt, first determine how much money you take in and how much you need to spend on necessities like food, housing and utilities.
If you find yourself in debt already, then to get yourself out of it you might find that you need to significantly cut down on unnecessary spending. Consider cutting cable, saving on your wireless plan or cooking all meals at home and using that extra money to pay down your debt faster. You’ll feel liberated as you watch those balances decrease.
2. Pay your bills on time
If you pay a bill 30, 60 or 90 days late, it will be reported to credit bureaus and will negatively affect your credit score. If you can’t pay your bill in full, pay at least the minimum payment due to avoid late fees and a negative hit to your credit score.
3. Determine which accounts to pay first
With a list of your debts in hand, pay attention to those with the highest interest rates. While you might think it’s best to pay the accounts with the lowest balance first, it’s really the interest rate that’s more important here. The higher the interest rate, the more money you’ll pay over time. So, if you have debt with three separate credit cards, target those with the highest interest rates first and pay more towards them each month. The sooner you pay off the debt, the less extra money you’ll spend.
4. Pay more than you owe
If you can, pay more than what’s due. A credit card should always be paid in full each month, otherwise you’ll pay interest on the outstanding balance and your bill will keep getting larger instead of smaller. If you’re already in over your head with credit card debt, continue to pay as much as you can each month and do not use the card to avoid adding any new expenses on to it.
With an installment loan, such as a mortgage, student loan or car loan, try and pay more than the monthly bill. You’ll pay less interest in the end and depending on how much more you pay each month, you’ll shorten the length of the loan by months or even years!
5. Monitor your credit
It’s important to understand how debt impacts your credit score and the best way to do that is to monitor your credit. Sign up for a free credit monitoring service like Credit Karma or Credit Sesame. You’ll be able to see a list of your current debts and spot any fraudulent activity.
These companies will provide insight on ways to improve your credit score. For example, maxing out your credit limits will likely bring down your credit score. Keeping the balance of your revolving lines under 30% of your credit limit is ideal – and by monitoring your credit, you’ll be able to see this type of information. You’re entitled to a free copy of your credit report each year and companies like Experian and annualcreditreport.com can provide that.
6. Reconsider closing accounts
Closing credit card accounts might be tempting when trying to take control of your debt, but it’s probably not the best move. If you close one or more accounts, it will decrease your available credit – automatically increasing your revolving credit usage. A card with no balance and a good payment history is best left open and unused.
7. Create an emergency fund
While you’re doing your best to pay off debt, creating an emergency fund might not seem feasible. But, as soon as you can spare a little extra money, start building your fund. That way, next time you have an unexpected expense, you won’t charge it to your credit card and earn interest on it, you’ll already have the money saved. The ultimate goal is to save 6 months of living expenses in your emergency fund.
8. Get help if you need it
Sometimes, the burden of debt is too much to handle by yourself. If you need guidance on how to get yourself out of debt, contact a credit counseling company. What may be described better as “debt counseling”, since they don’t directly help you improve your credit, this type of service will evaluate your debt situation and help you develop a plan to break free of your debt. A counseling session will not cost you any money.
Sometimes, the credit counseling agency might suggest you’d benefit from enrolling in a debt management plan, which could result in reduced interest rates, elimination of late or other fees and re-aging of past due accounts to a current status. If you choose to enroll in a plan like this, then there would be fees for the agency’s services.
If you follow the steps above, you’ll be on your way to being in control of your finances – and feeling liberated from the crushing weight of debt.