What does the American dream look like to you? Does it include a home of your own, a car or two in the driveway and a career that helps you feel happy and fulfilled? Maybe you want or have children, too, regardless of how much it costs to raise them.
Unfortunately, pursuing these dreams can be a costly endeavor. A car and a house, for example, may each require a loan. If you want both, the cumulative effect of those loans can be devastating.
Consider the following debt statistics:
High debt could make it difficult to realize your financial dreams. But there are plenty of ways to borrow less, pay off debt you already owe and gain more financial freedom.
Hereâs a deep dive into the kinds of debt you may face, as well as practical solutions to help you organize, reduce or pay off debt that stands in your way.
Not all debt is created equal. There is debt that can help you build wealth, and there is debt that prevents you from building wealth. Itâs important to know how to identify which is which. Consider the following.
Tony Liddle, a Wisconsin financial adviser who works for Prosper Wealth Management, said itâs important to note the difference between good and bad debt so that you can focus your debt payoff efforts on the debts that matter most.
Generally speaking, a mortgage for a home you live in is good debt, he said. Your home may go up in value, and everyone needs a place to live. It is also difficult and time-consuming to save up the money to pay for a home in cash, especially in areas of the country where real estate is pricey. So taking out a home loan may be necessary.
But thereâs a limit to good debt, since itâs far too easy to borrow more than you can afford. Thereâs a fine line for sure, but itâs possible to buy more house than you need and wind up with a mortgage payment you canât afford.
The same can be said for car loans, Liddle said. You may need a car to get to work, but you may not need to borrow the maximum a lender offers.
Student loans can also run in the same vein. Borrowing money to earn a college degree can pay off in spades over the course of your career, but borrowing more than you need to graduate isnât always smart.
Regardless, itâs important to prioritize your debt so your money is going where it will count the most.
Financial adviser Don Roork, of AssetDynamics Wealth Management and Wisdom for the Wealthy, said consumers should focus on paying off unsecured debt first. This includes debt such as credit cards and personal loans. Thatâs because unsecured debt can make it difficult to build wealth, but itâs also because it tends to come with higher interest rates. The average credit card currently has an APR of 15.5%, for example.
Hereâs one way you may want to prioritize your debt repayment:
While credit cards can be convenient to use, the exorbitant interest rates they charge can make it difficult to repay balances over time. We already mentioned how the average credit card interest rate is 15.5%, but many credit cards charge even higher rates â particularly to borrowers with poor or fair credit.
Liddle also noted that the gimmicks that credit card issuers come up with can make it hard to avoid them. Some cards offer rewards for every dollar you spend, for example. Offers for 0% APR could also tempt you into spending more than you planned.
If you do wind up with credit card debt that youâre struggling to repay, Liddle said it can interrupt your life in too many ways to count.
âYou canât advance your financial life with investing when youâre throwing all your money into debt and interest payments,â he said. And if you keep making the minimum payment, youâre mostly just paying interest and avoiding real progress. âYouâre basically just treading water at that point, which will never help you get out of debt.â
If you want to pay off credit card debt, several strategies can help.
Some credit cards offer 0% APR on balance transfers for a limited time â usually between 12 and 21 months. These cards let you avoid interest payments during that time, which can expedite your debt payoff process.
Liddle said balance transfer offers can be valuable tools if used strategically, but you should beware of balance transfer fees that can be as high as 5% of your balance. Also, note that your introductory APR only lasts for a while before resetting to a much higher rate.
You can also look for a balance transfer card that doesnât charge any balance transfer fees. Nick Clements of MagnifyMoney said this option is best for consumers with relatively small amounts of debt ($5,000 or below) that they can pay off quickly.
Mike Sullivan, a personal finance consultant with nonprofit credit counseling agency Take Charge America, said itâs possible to negotiate with your creditors if youâre falling behind on your payments.
âMost creditors have hardship programs that extend payments and reduce interest rates but do not reduce balances owed,â Sullivan said. You could negotiate down your interest rate or monthly payment, but youâll still have to pay off your debts in the long run.
Sullivan said no creditor wants to be the one left holding the bag while others collect. Itâs best to notify all creditors that you cannot and will not be paying off entire debts if you donât believe you will be able to do so.
From there, you can make an offer to pay about 50% of your balance over three years, or 20% immediately in exchange for a written statement that the amount has been accepted as payment in full for the debt.
Thatâs just a general suggestion, and this strategy doesnât always work. But you may want to give it a try if you have credit card debt you truly cannot pay off. Also keep in mind that there are debt settlement companies who can assist you with this process.
If you have the means to pay off your credit card debt over time, you may make more progress if youâre strategic about it. These two debt repayment strategies may help you stay motivated as you get ahead on your finances.
Either method asks you to pay as much as you can toward the prioritized balance until itâs gone while making the minimum payment on the rest of your debt. Use this calculator to find out which method is better suited for you.
Personal loans come with fixed interest rates, fixed repayment schedules and fixed monthly payments that can make paying off debt easier to plan. You may also qualify for a much lower interest rate depending on your creditworthiness. Clements said personal loans are good for people who need a longer timeline to repay their debts and prefer the stability of a fixed-rate, fixed-payment loan. Use our table below to compare multiple options to get the lowest interest rate!
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No matter what strategy you use to pay off credit card debt, itâs far too easy to fall back into old habits. Here are some strategies that can help you avoid getting into more debt once youâve paid it off:
A car loan can be a valuable tool if you need a vehicle to get to work and canât afford to pay in cash. But not enough people realize just how harmful huge car payments can be, and far too many tend to buy more car than they can truly afford. Very often, those who take out car loans with bad credit have it the worst since they tend to pay higher interest rates.
Roork said that, most of the time, it boils down to self-image. Consumers want to look like they have money, so they take out car loans for tens of thousands of dollars and pledge to pay them off for up to 84 months. But those $500-plus payments can make it difficult to save money and keep up with other bills. And since automobiles are notorious for depreciating at a rapid pace, huge car loans are akin to setting money on fire.
If you havenât borrowed money for a car yet and donât want to make a life-altering car loan mistake, Liddle said itâs wise to limit your loan to just three years. That way, your larger monthly payments have a better chance of keeping up with depreciation as your car loses value. Plus, youâre not making such a lengthy commitment.
If you have a car loan already and you want to pay it off, consider these strategies.
If your car loan has a high interest rate and you believe you can get a better deal, it may be possible to refinance your auto loan into a new loan with a lower interest rate and better terms. If you do get a lower interest rate, refinancing can help you secure a lower monthly payment or make it easier to pay your loan off faster if you continue paying the same amount youâre paying now.
Paying more than the minimum payment on your car loan can help you get out of debt faster. Make sure your loan doesnât have any prepayment penalties, then pay as much as you can each month, whether that means rounding up your payment to the next hundred dollars or adding whatever you can.
If you owe less than your car is worth, you can also sell your car by owner (or through trade-in at a dealership) and start over with a less expensive car. If you owe more than your car is worth (e.g., you owe $10,000 on a car worth $8,000 according to Kelley Blue Book), you will need to make up the difference when you sell.
According to the Bureau of Labor Statistics, Americans with a high school diploma earned an average of $712 a week in 2017, while those with a bachelorâs degree earned $1,173. Workers with a professional degree earned average wages of $1,836 a week last year, while doctoral graduates earned slightly less.
As you can see, student loan debt can be good debt if used wisely. While you are borrowing money to attend college, your loan can pay off in the form of higher earnings for your entire career.
The good news is, federal student loans tend to come with low interest rates and fixed repayment schedules. For that reason, it makes sense to focus on paying off higher-rate and unsecured debts first.
But that doesnât mean your monthly student loans are affordable or easy to handle â even if theyâre at a lower interest rate. If you need your student loan payments to be lower, consider these strategies.
While the standard repayment plans for federal student loans last 10 years, you can opt for an extended repayment plan that lasts for up to 25 years. Youâll secure a lower monthly payment this way, although youâll need to pay on your loans for a longer stretch of time.
Income-driven repayment (IDR) plans let you pay a percentage of your discretionary income for up to 25 years before forgiving your remaining loan balances. Read about the pros and cons of IDR plans before you consider this option.
There are myriad student loan forgiveness options, ranging from Public Service Loan Forgiveness (PSLF) to special forgiveness for teachers and members of the military. Read about student loan forgiveness options to see if you qualify.
If you have excellent credit (or a cosigner with excellent credit), you may be able to refinance student loans with a private lender who can offer a lower interest rate. But keep in mind that you give up federal protections such as forbearance and deferment, along with access to IDR plans, if you refinance federal loans with a private lender.
Letâs say you donât care to lower your monthly payment but prefer to pay your student loans off as quickly as possible instead. Consider these tips.
If you can refinance your student loans with a private lender and get a lower interest rate, you can pay less in interest each month and pay your loans off faster. As we mentioned already, you will give up federal student loan protections and benefits if you refinance federal loans into private loans.
Paying as much as you can toward your student loans each month will help you get out of debt faster, particularly if you can make extra payments regularly. Since interest accrues on unsubsidized loans during school, making regular payments on those loans can save you even more.
While some student loans donât require payments until after you graduate or after your grace period is over, you should start making payments while youâre still in school if you can. Doing so will reduce your loan balance and help you get out of debt faster.
Some student loan servicers offer a .25% discount if you set up your payments to be done automatically.
The debate over whether to pay off your mortgage has waged on for years. Some experts suggest that you should take as long as possible to pay off your mortgage since you likely have a low interest rate and may be able to write off mortgage interest on your taxes. Others who are averse to debt would rather you pay off your mortgage loan early.
There is no right or wrong answer here, but you may want to focus on paying off your mortgage once your other debt is gone. If you have an adjustable-rate mortgage (ARM) and you worry interest rates may rise, for example, focusing on mortgage debt could be a smart move. Perhaps you are less than five years from retirement and want to make sure you have all debt paid off before you settle into a new life with a fixed income.
Maybe you just dislike debt and no longer want to owe anything to anyone. Provided other more important debts are paid off, this is OK as well.
But Liddle notes that you could be better off investing your money instead of prepaying your mortgage. If you have a fixed-rate mortgage loan at 4% APR but you could earn 8% in the stock market, then paying off your mortgage may not be a great deal over the long haul. But again, the right answer for you depends on your attitude toward debt, your appetite for risk and your goals.
If you are seriously considering paying your mortgage off early, here are a few ways to do it.
Several government-backed mortgage modification programs exist to help homeowners, including the Home Affordable Refinance Program (HARP), Federal Housing Administration Streamline refinancing and Veterans Affairs Interest Rate Reduction Refinance Loans (IRRRL). These programs can help you qualify for a lower interest rate that can make paying off your mortgage faster a much easier task.
You can also refinance your mortgage through traditional means, either to reduce your interest rate, your repayment timeline or both. Refinancing a 30-year loan into a fixed-rate 15-year loan may help you secure a lower interest rate and cut years (or a decade or more) off your repayment timeline, for example. But keep in mind that youâll have to pay closing costs on a new mortgage loan.
You can also consider selling your home and starting over, keeping in mind that the average real estate agent will charge 6% to sell and market your home. If you were able to sell your home and turn a profit after real estate fees and moving expenses were factored in, you could purchase a less expensive home and start the process over.
Also keep in mind that you can pay off your mortgage faster by making extra payments or biweekly payments. With extra payments, you can either round up your payment each month to an amount you can afford or strive to make at least one extra mortgage payment each year. You could also opt for biweekly payments that would result in one extra mortgage payment being made every 12 months since you would make 26 half-payments instead of 12 full mortgage payments.
No matter how hard you try to stay on top of your debts, there are times when itâs easier just to let things go. Unfortunately, late payments can hurt your credit score and result in late fees and fines that make catching up that much harder.
While creditors may try to collect on a late debt themselves for up to 180 days, your debts in default will eventually be sent to collections. âAt that time, the companyâs bottom line takes a hit for the amount owed,â Sullivan said.
Some creditors have in-house collections professionals, while others hire outside firms to contact consumers to see if they can get them to pay. Sullivan said, sometimes, creditors will just sell off their outstanding debts to collections companies. Either way, someone is eventually going to contact you about the amounts you owe.
Debt collectors tend to get a bad reputation since they are known for hounding debtors at home and at their jobs. Sullivan even said many debt collectors will intentionally try to make the experience uncomfortable so youâll just pay what you owe to get the calls to stop.
Fortunately, the Fair Debt Collection Practices Act (FDCPA) spells out limits for debt collectors, as well as penalties for those who threaten, call too late at night or contact employers and family members.
According to Sullivan, the FDCPA permits consumers to notify collectors in writing that they must stop all communication with that consumer, but many do not know this or fail to take advantage of it. Make sure to read up on the FDCPA at our parent company, LendingTree, and know your rights if you feel you are being unfairly targeted or the victim of abusive practices.
The best way to deal with debt in collections is to deal with debt collectors directly and honestly, Sullivan said. If you decide not to repay your debts and send a letter to ask debt collectors to cease communication per FDCPA rules, debt collections calls should theoretically come to an abrupt halt. If the calls do not end, keep careful records of all contact. âA consumer can take a collector to small claims court for violations of the law and cash awards can be substantial,â Sullivan said.
If you do want to pay off your debt and strike a deal, Sullivan said to put your negotiation cap on. Often, debt collection companies pay only a fraction of the price of your debt to take it over. With that in mind, you could offer a fraction of what you owe and still help them turn a profit. Imagine you owed $10,000 in credit card debt and it got sent to a collections agency that paid only $2,000 to acquire that debt, for example. Even if you offered $3,000 (30%) of the amounts you owed, the collections agency may be inclined to accept it.
The key is to agree on an amount that ends all collection efforts while helping the collection agency get its investment back.
While it may be tempting to ignore debt collectors altogether, this strategy can backfire. Keep in mind that debt collectors can take steps to have your future wages garnished until the debt is repaid, provided the statute of limitations for the debt isnât up (varies by state), so you canât just wish it away. Consumers also need to understand that if wage garnishment is successful, their total debt owed can balloon because of late fees, legal fees and interest, Sullivan said.
If youâre at the point in your journey where you know you need legal help to get out of debt, it might be time to explore bankruptcy. There are two main types of bankruptcy to consider:
While both types of bankruptcy could be beneficial depending on your situation, itâs likely that youâll only qualify for one or the other.
Chapter 7 bankruptcy has a âmeans testâ that limits the amount of income you can have and still qualify, for example. You can only file for Chapter 7 bankruptcy if your income is lower than the median income in your state for your family size. This type of bankruptcy may require you to sell your assets, but your house and cars are protected up to certain amounts that vary by state. Retirement accounts, including 401(k), 403(b)s and IRAs, are also protected fully or up to certain limits.
With Chapter 13 bankruptcy, you need to be able to prove you can afford a repayment plan. You also must have filed both state and federal taxes in the last four years, and have total secured debts below $1,149,525 and total unsecured debts below $383,175. But you do not have to sell any property to make up for shortfalls when you file for Chapter 13 bankruptcy.
Filing for Chapter 7 or Chapter 13 bankruptcy requires an in-depth knowledge of the law and your finances. Further, the U.S. government said mistakes and misunderstandings in your case have the potential to threaten your rights. For that reason, it is strongly recommended that you hire a qualified attorney to help with your bankruptcy case.
Regardless, you can file for bankruptcy on your own and without an attorneyâs help. Bankruptcy forms are also available for free online. Bankruptcy is best used as a last resort. Debt consolidation is an option that should be considered before filing bankruptcy. You can compare the two options here.
If youâre someone who is determined to pay off debt that you owe, itâs important to approach your goals with the right frame of mind. Clements said that without the right mindset, no debt-payoff strategy can help you. This is especially true if youâre thinking about refinancing your debt or reorganizing it with another loan.
âBefore you think about any product that can reduce an interest rate or shorten a repayment term, you need to make sure you solve the budgeting problem first,â Clements said. âFar too many people think that a balance transfer or debt consolidation will solve their problem, but it wonâtâ â at least, not until the underlying spending problem is addressed.
If you use a balance transfer card to secure 0% interest and pay down debt but continue using credit cards for purchases you canât afford, youâre not going to end up any better off once your cardâs introductory offer is over, he said.
Here are some of the steps you can take to set yourself up for success:
A monthly budget can help you manage your income and your expenses while also keeping you accountable for each dollar you spend. While there are plenty of budgeting apps out there, you can also budget using a pen and paper. Write out all your bills and all your monthly expenses so you can keep track of where your money goes each month, and youâll be much better off.
Also take the time to track your spending from the last few months. Break out your bank statements and credit card bills, then tally up how much you spent each month in fluctuating categories such as food and dining out, entertainment, transportation, cable television/internet, clothing, etc. You may be surprised at how much youâre spending in certain categories. If you find areas you can cut in your budget, you can reallocate those extra funds toward your debts.
Both Liddle and Roork suggested a similar approach to emergency funds. Build a $1,000 to $2,000 temporary emergency fund as you pay down debt by saving what you can each month, even if itâs just $50 or $100. Once youâre free from consumer debt, try to save up 3 to 6 monthsâ worth of expenses to cover emergency medical bills, surprise car repairs, job loss and other surprises life might throw your way.
Automating some of your important bills can also help you stay on track with your spending and goals, particularly if youâre using a budget each month. Automate recurring payments and keep track of them in your monthly budget so you never forget when theyâre due and always have money set aside for them. And remember, you can automate payments toward recurring bills and your debts.
Life without debt can be a reality, but it takes a lot of work to get there. Not only do you have to focus on paying off the debts youâve amassed, but you also need to learn how to avoid debt in the future.
Roork said the key to living debt-free is making sure your lifestyle aligns with your wages â not your wants. If youâre debt-free and budgeting each month, it should become very apparent how much you can afford for housing, food and fun, while also reaching your financial goals. And thereâs nothing wrong with occasionally splurging, provided your bills are paid and your needs are met.
Itâs all about balance.
âBalance todayâs lifestyle with the life you want in the future,â Roork said.
To that end, both Liddle and Roork suggest getting on track with your retirement goals once youâre debt-free â or even while youâre paying off debt. If your employer offers a 401(k) or similar plan and you havenât opened an account yet, doing so should be your first step.
Contribute at least enough to get an employer match if your employer offers one. But both advisers said to aim to save 15% or more, including your employer match, if you want to build up a nest egg you can retire on. Of course, it never hurts to save a lot more than that if you can afford it.
If youâre self-employed, you can open your own retirement account. Consider a SEP IRA, Solo 401(k) or similar retirement account to start saving on your own.
Also remember that anyone can open and contribute to a traditional IRA and may be able to deduct their contributions on their taxes depending on their income. You can also open a Roth IRA, provided you meet income requirements. Keep in mind, however, that you can only invest up to $5,500 a year across both a traditional and Roth IRA ($6,500 if youâre 50 and older).
Besides investing for retirement, youâll also want to make sure youâre saving money for other goals you might have. After all, you will likely want to enjoy the spoils of your debt-free lifestyle to a certain extent. Perhaps you want to take a vacation, remodel your kitchen or upgrade to a nicer home. Once you are debt-free, all those goals become easier to accomplish provided you make savings a priority.
We already mentioned how you should strive to save three to six months of expenses for emergencies, but you can also set up savings accounts for other goals, such as for your childâs college education or travel. You may strive to put away at least 10% of your income in cash (outside your retirement accounts) for these goals.
Open a high-interest savings account (or several) and set up automatic deposits in amounts you can afford, whether thatâs $100 a week or $100 a month. The key to building up savings is making sure your contributions are consistent and keeping your accounts out of sight so you arenât tempted to spend money youâve saved.
A life without debt is entirely possible, and there are myriad benefits to enjoy on the other side. With enough time and hard work, you can build a life that requires few bills or financial stress. You can start saving and investing for a future you can be excited about, and you can break the paycheck-to-paycheck cycle that has plagued you so far.
But like anything else, this process wonât start on its own. Debt freedom wonât magically appear one day, just like money wonât fall out of the sky.
Believe in yourself and focus on the life you want, and you can get out of debt with enough time. Digging your way out of debt wonât be easy, but it will be worth it.
Disclaimer: MagnifyMoney and Student Loan Hero are LendingTree companies. This article contains links from Student Loan Hero and LendingTree.
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