It’s practically a given that you’re in debt. According to a report from the Pew Charitable Trusts, 80% of Americans have some form of debt and 39% of Americans have credit card debt, which is typically high interest debt. And 69% said debt is a necessity in their lives! It doesn’t have to be…paying off debt helps to bring financial security to your life. As part of America Saves Week 2017 (#ASW17), today I’m going to talk about how to pay off high-interest debt.
While a low-interest mortgage to secure housing or education may make sense, carrying high-interest credit card debt is a financial disaster waiting to happen. Some of us can’t stay away from racking up huge debt no matter how much money we earn. It has little to do with age, gender, background, or even where you live. It is, however, a common thread that results in spending money we just don’t have. Habits like that are not only hard to break but can result in financial suicide. It happens every day to someone.
Unfortunately, there are also times, no matter how hard you try to prevent falling into debt, when it can’t be helped. Medical emergencies are often a big cause. Losing your job, along with poor health or some other kind of personal crisis like a divorce can certainly put you in a real financial bind.
No matter how you’ve gotten into debt, there are a couple of things that you can do to help prevent a potential financial disaster which can happen to anyone at any time.
Steps to Paying Off Your High-Interest Debt
1. Build Up an Emergency Fund
Building up your emergency fund is your first line of defense and something every financial advisor will tell you is essential to your financial security. The time to do it is now. It’s always, now. You simply have to take a portion of your earnings every week and put it into an interest-bearing liquid account such as a savings account. This has to become ingrained in your habits and it has to come before anything else.
The car can break down, you may need to buy a new refrigerator, or some other event even worse can happen. Although you can use credit if you have it, your emergency fund will prevent you from doing things like racking up debt by using your cards for one time emergencies and also your everyday routine expenses. That card may be just the reason you are in mess in the first place!
If you have to spend extra money this month for an unplanned event, do you have an emergency backup? Imagine what might happen if you lost your job? Could you pay your rent? Your car payment? Could you even buy food?
The money you need to save during the “good times” varies depending on your personal situation and your lifestyle. But no matter what you actually live on each month after month, you should plan to have a minimum of 6 months of “bare bones” expenses in reserve, even more if you can. You have to err on the side of caution to prevent real disaster.
2. Maintain or Rebuild Your Credit
Having a good credit score is really important. Even if you do not regularly have credit needs, if you ever do need your card, the interest rate you might have to pay is directly connected to your responsible past payment history. High interest may be the reason you can’t pay off your balances quickly. It goes without saying that carrying a high-interest credit card debt month after month can cause a significant problem for you. Use a credit calculator to see how even a 1% difference in rates can sabotage your plan to pay off your debt.
Using too much of your available credit for your everyday expenses will lower your score just as significantly as missing a payment or always carrying a balance and not ever paying off your debt. If your creditors are worried that you aren’t paying off your high-interest debt, you should be too. You should always be monitoring your credit score for free and trying to improve on it.
Having a good credit score will get you the better interest rates and also better balance transfer offers, which you can use to consolidate at a lower interest rate.
3. Consolidate Your Debt at a Lower Rate
One option you have is to consolidate your debt into a single lower-interest payment. This can only be done if you still have a good credit rating. There are numerous low and even “0% interest” options out there that will approve you if in fact your credit rating is good enough. When you lower or eliminate the high interest, suddenly you are able to knock out your debt much more quickly. There are many people who can only make minimum payments on their debt which will only cover the interest due, an action that will make your debt stick around for years and years with no hope of escape. Don’t let that happen to you, ever!
When using the debt consolidation, shop around for the best deal and use a calculator to make sure it works for your situation. Read the entire fine print too. What happens if you’re late? Do you lose the lower rate? What happens if you go beyond the no-interest period before paying it back in total? Do you lose the rate after 12, 15 or 18 months? What upfront fees are there to get the rate? It can vary from 1% of what you borrow to as much as 6-7%. That would be hundreds of extra dollars tacked on to your already huge debt. Check to make sure you know what you are getting involved with.
You may want to also consider getting yourself some sort of consolidation loan through your bank. That can take several forms and will usually have much lower interest rates than credit card land. A personal loan from the bank again will rely on your credit rating and outstanding debt.
Finally, if you’re a homeowner, you can consider a Home Equity Loan or a Home Equity Line of Credit, both of which are low interest and easier to get because of the collateral you have in your home. If you have a good record of payment and you apply at your bank, it may be approved and paid off fairly quickly for most people. In many cases there are no or low fees to obtain them. Your credit rating plays a role in this loan. If you go with the line of credit, it is ongoing open credit, meaning once you pay back the amount borrowed, it will be available to borrow again such as for an emergency.
4. Debt Snowball or Debt Avalanche
If consolidation isn’t available to you, there are two basic methods to pay down your debts. With the Debt Avalanche, you pay the minimums on all debts and put extra money toward the highest interest debt until that is paid off. Then you would put extra money towards the next highest interest rate debt, and so on. Mathematically, this helps you pay off your total debt most quickly.
With the Debt Snowball, you pay the minimums on all debts and put extra money toward the smallest balance debt until that is paid off. Then you would put extra money towards the next lowest balance debt, and so on. Mentally, this gives you a boost because you’re eliminating individual debts more quickly. Either way works, just decide what’s right for you.
5. Stop Adding to the Debt
Do not open new lines of credit if you can avoid it. Your best method is to face debt head on and simply use every means possible to pay it off. Stop using credit for any new purchase. For many people, going back to cash (or debit cards) is the best way to wean themselves off of credit.
6. Finding Money to Pay Down the Debt
The basic fact is this: your debt won’t disappear until you start spending less than you earn. Pay extra to your debt and give up some of your luxuries until you get into a better financial place. Make adjustments in your life like temporarily getting a second job, side hustle, or sell some of your personal things like your car, your golf clubs, or your wasteful spending habits like Starbucks morning coffee or takeout meals every other night.
If you don’t already, make sure you track your expenses and set a budget. These activities will help get you out of debt and on the right track.
Cutting your expenses to save and using that money to pay down debt works and is easy to accomplish if you plan out the time and details in advance. There will be a tremendous amount of personal satisfaction if you do just that and will probably never have to do it again in your life.
The goal of course is to get out of debt. But even bigger than that is the promise you make to yourself to never let your credit get out of control again.
Are you prepared for an emergency if one arises? Have you made a habit of controlling your high interest credit card debt or are you in trouble right now?