How can I get out of debt?
Whether you’re having sleepless nights, struggling to save for the future or have been rejected for a mortgage or credit card, outstanding debts can be a real problem. So how can you cut your debts and what steps can you take today to start planning for the future?
Debt in the US
Debt in the US is on the rise. The average American now owes a record $92,727 in personal debt, with 43 per cent of people expecting to add debt in the next six months.
Between the pandemic and the economic turmoil that is continuing to impact people around the world, rampant inflation and geopolitical conflicts, more and more Americans are struggling to make ends meet.
And with so many people expecting to add to their total debt in the coming months, more Americans are turning to credit cards to absorb the debt.
While the average credit card debt already stands at $5,769, 22 per cent of those expecting to add to their debt intend to use their credit card to do it.
The challenging circumstances facing almost all households means that many people are facing up to growing personal debts in the coming months. But should your debts grow to be too large, you could quickly end up facing major problems.
What is the impact of debt?
On the one hand, should your debts grow large enough that your own income may no longer be enough to pay them off, you’ll start to run into difficulties when it comes to getting loans, applying for mortgages or even financing your car.
One of the main ways credit lenders assess your ability to keep up with long-term repayment plans is by looking at your income and your debt-to-income ratio, which measures how much of your regular income will be used to pay back debt.
Should your debt-to-income ratio grow to a level of around 43 per cent or above, lenders will start to get cold feet and will be reluctant to give you more money, so your financial goals will remain out of your grasp until that ratio comes back down.
So, debts can be a major block when it comes to reaching financial milestones. Should your debts start to spiral, they can also start to impact your mental health and wellbeing.
Debts can cause sleepless nights and can cause you to struggle with anxiety and even depression and hopelessness when it comes to thinking about the future.
And it’s not just you that will feel the burden — your personal relationships can suffer too.
Nearly 40 per cent of divorcing couples cited financial issues as one of the leading factors behind the break-up.
So, for your own wellbeing and that of your personal relationships, it’s important to manage your debts to keep a balanced and happy life.
Strategies for getting out debt: Snowballing or avalanching?
The first step to getting out debt is facing the music — that is, finding out how much debt you really owe.
While trying to avoid the true amount of debt is understandable, the most important thing to do is to figure out how much you really owe and what your interest repayments will be.
With this all figured out, you can then start planning a strategy to reduce your debt levels.
Two of the most popular strategies for taking control of your debt are debt avalanching and debt snowballing.
While both methods are equally popular for paying off debts, the avalanche method is generally more popular if you have higher levels of interest to repay, and you prefer to tackle your debts strategically.
Very simply, the debt avalanche involves making minimum payments on all outstanding accounts while using any other money to pay off the highest interest rates.
As a result, this is a good way of reining in high levels of interest that can often make your debt unmanageable.
However, this does still mean that certain amounts of principal debt will remain outstanding for a longer period of time, meaning it can often feel like you’re not really paying off your debts.
Snowballing does the opposite: You’ll tackle the smallest and most manageable debts first and will have the satisfaction of seeing your debts being paid off, one by one.
Snowballing can sometimes be easier for people who struggle to budget as you get to focus on one debt at a time.
But, by tackling the smallest debts first, it could take longer to get around to the debts that have the highest levels of interest, meaning it could take longer to pay off your debts in total.
Alternative tips for getting out of debt
Pay more than the minimum payment: If you’re able to, paying more than your minimum obligations can make a big difference to your outstanding debts. If you had a $15,000 credit card balance and a 17 per cent APR, paying a minimum of $450 a month would see you repaying for four years, with a total interest repayment of $5,500. Paying $550 a month will see you repay in less than three years, with your interest only coming to $4,100.
Use windfalls to pay off your debts: It’s easy to want to spend any windfall — whether it’s a work bonus or an inheritance — on yourself. But windfalls can be a blessing in disguise when it comes to debt repayments, as they can make a big dent in your debts and interest repayments.
Consolidate your debts: If you’re paying back multiple debts at different times of the month, it can be hard to work up a bank of funds to plan for the future. You may be able to consolidate your different debts into a single repayment to a lender.
Negotiate with your debtors: You may be able to settle some debts with your lender simply by speaking to them. You could do this yourself, but there are also many businesses out there who can do this on your behalf.
Getting out of debt with bad credit
Bad credit can pose an obstacle to getting out of debt, but it is a challenge that can be overcome.
Typically, the best way to deal with debt while having bad credit is to take out a debt consolidation loan that uses a secured asset as collateral.
These loans will need to be secured by a valuable enough asset that could be used if you weren’t able to keep up with your consolidation loan.
But by using a secured asset, you can still get a consolidation loan even with bad credit.
Managing your debts can help you achieve your financial goals while saving you from sleepless nights and lots of stress.
Kate has written for leading publications and blue chip companies over the last 20 years.