While student debt gets a lot of attention, the United States has an overall debt problem. Believe it or not, the average American owes over $90,000 in debt, which is a dramatic increase in just the last few decades.
Often, this debt overwhelms us and it feels as if there is no escape. Luckily, we can help put this behind you. Let’s talk about how to get out of debt and stay out in 2022!
Different Types of Debt
There are two umbrella terms for debt, namely installment debts, and revolving debts. Installment debts are the loans for a large purchase for which you make regular payments until it is paid off. Mortgages, auto loans, student debts, and business loans fall into this category (along with others).
Revolving debts are debts that can revolve between payment periods as you take out more debt or pay it off. This includes credit cards (secured or unsecured), payday loans, HELOCs (home equity lines of credit), and others.
Conversely, revolving debts tend to have much higher interest rates, and often no collateral. The average person may find mortgages and auto loans for under 5% interest, with the home or vehicle acting as collateral.
Also, those same borrowers may use a credit card with over 20% annual interest. Usually, revolving debts are the types that cause the most financial issues, especially when used improperly or after periods of financial hardship.
Should You Pay Down Installment Debts?
You may be reading this to determine how to pay off your long-term installment debts like your mortgage or student loans. Well, that’s a great idea, but only in certain contexts.
Full disclosure: this is a widely debated issue among financial advisors and economists. Some people say paying down a mortgage or student loan should come before investments, and some disagree. It’s a matter of personal preference.
However, we will say that if you’re receiving returns of 6% annually on your investments and your mortgage has an interest rate of 3%, then it is worth it. Just remember, returns aren’t always guaranteed.
Consequently, if you’re putting that money into a savings account that yields 1% interest, then it’s probably worth it to start paying down your mortgage. That is, assuming you keep some money in your savings.
Why You Should Get Out of Debt
Of course, there are dozens of reasons to get out of debt, and plenty more based on your individual goals. However, there are plenty of reasons why everybody should prioritize paying off their high-interest debts. Here are just a few examples.
Boost Your Credit Score
Understanding credit scores and how they affect your financial health is important, as these three simple numbers control much of your mobility in life. If you want to start a business, go back to school, or buy a house at some point in your life, then you need to establish a decent credit history.
Buying a house is the biggest purchase of most people’s lives. Let’s say you want to purchase a home with a $300,000 mortgage. Well, someone with ample income but poor credit may never get to live in that house.
Conversely, somebody with the same income and mediocre (or even average) credit may get to take out that mortgage, but at a much higher rate. If you’re going to remember one thing about interest rates, let it be this: even seemingly small differences add up.
For example, somebody with a $75,000 income and a 760 credit score will likely have no trouble getting a $300,000 mortgage at 2.49% interest. However, somebody with the same income and a 630 credit score may get the loan, but with a 6.49% interest rate.
Well, in that context, that small seemingly small difference is $12,000. Would you spend an extra $12,000 on a car or college tuition if you didn’t have to? If not, then why would you on a house?
Whether it’s in the context of a 30-year mortgage or a 5-year loan, $12,000 is still $12,000, and that’s only for one purchase. Establishing a quality credit score will save you thousands upon thousands of dollars throughout your life.
Focus on Savings or Investments
There is one hard truth that every adult needs to come to terms with, and the sooner, the better: retirement should be your primary goal. Nobody wants to reach retirement age only to find out that it isn’t in the cards for them.
Well, if there’s one thing you know about Social Security, it’s probably that you can’t rely entirely on it for retirement. Consequently, you need to have a plan.
Whether you’re 18 or 45, retirement should be a the forefront of your financial goals. The longer you have to prepare, the more secure your retirement will be. However, believe it or not, 1 in 4 Americans don’t have any retirement savings.
Moreover, it’s hard (often impossible) to save for retirement if you are swamped with debt. Getting out of debt as soon as possible is the only way to alleviate that stress.
Not worried about retirement yet? Well, there are dozens of other things worth saving for, depending on your circumstances. Saving for a down payment on a home, emergency fund, starting a business, or anything else will also require you to pay off your debt first.
Peace of Mind
Let’s be frank and say that debt is stressful and you’re not alone in thinking that. 73% of Americans agree that finances are the greatest stressor in life and that only gets worse with increasing debt.
When you’ve been surrounded by debt for a while, you often forget what it’s like to be out of it. Once your debt is cut in half, you continue to see the debt shrink, and you finally get out of the hole, it offers a sense of relief unlike any other.
How to Get Out of Debt
Now that you know some of the key benefits of getting out of debt, we can talk about some important strategies for getting out and staying out. Here’s how to start.
Of course, to find success in your debt relief, you have to make it a priority. Not only that, but you have to prioritize which types of debt you need to eliminate first. Don’t be afraid to take the time, sit down, and look at your financial situation.
Once you have an idea of your debt, plan it out. It doesn’t hurt to make the minimum payments on certain debts while attempting to pay down others faster. You just need to know which ones are most important.
For example, unless you’re in deep with a loan shark, any payday loans will always go first. In some states, payday lenders can charge annual interest rates well over 500%, meaning that you could find yourself trapped in mounting debt just after a one-time loan of under $1,000.
After that, credit cards typically go next. Most credit cards have an interest rate of 20% and 25%, and many go higher for people with poor credit.
For context, if you’re only making the minimum payment on a credit card with a $10,000 balance, you could wind up with an additional $2,500 after only one year.
If you have an auto loan, mortgage, or student loan balance that’s weighing on your conscience, don’t worry about that yet. Focus on revolving lines of debt (like credit cards) with high-interest rates first. You will not receive penalties for making the minimum payments on long-term installment debts.
However, if you don’t have credit card debt or any other high-interest debts, you may consider paying down these other ones as soon as possible. In that case, follow the same advice!
Create a Realistic Timeline
Once you’ve determined which debts are most important to eliminate, it’s time to create a realistic timeline for how you intend to get out of debt. Crunch the numbers and determine what your current monthly expenses are (including installment debt payments) as well as your income.
If you pinch pennies for a bit, how long will it take to get out of your current situation if paying down debt is your first priority? Of course, don’t forget to set some extra money aside, as there are always expenses we don’t think about, and everybody needs an emergency fund.
However, try to get a sense of the quickest possible way out with your current financial situation. From there, give yourself a couple of months as leeway and write it down. You are 42% more likely to achieve goals when they are written, so take ten seconds to write it out!
One of the greatest things you can do to get out of debt in the fastest way possible is to increase your income. By earning more money, you can easily put more into your debts than ever before.
We know what you’re thinking: “This is easier said than done.”
Well, there are plenty of ways you can increase your income these days. The digital age has brought about hundreds of opportunities for regular workers to take on a side hustle.
Driving for Uber or Lyft, delivering for DoorDash or Instacart, or taking on an online side hustle could give you the boost you need. Are you crafty? Sell things on Etsy.
Truly, there is something for every skill set, hobby, passion, interest, or just people with a driver’s license! Freelance writers, video editors, and plenty of other skilled workers are in high demand in the online gig economy, so if you have some skills that can be performed on a computer, look into your options!
Not only that, but you can also ask for a raise or extra hours at your primary job. Even a 2% increase to a $50,000 salary is still an extra $1,000 a year.
If you can increase your income and decrease spending, even by a little, you will double your capacity to pay down debt. It’s the same logic as a head-on collision where your speed essentially doubles upon impact.
Well, double your financial “force” by taking a hard look at how your money comes in, where it goes, and finding ways to save. The opportunities are endless for the average American.
For example, most Americans spend around $273 a month on subscriptions, most of which they don’t even use. If you find that you spend $200 on subscriptions and cut that in half, that small difference could put an extra $100 toward your debt each month.
Another easy fix is to pack a lunch and stop eating out. If you spend $10 a day at work on lunch, which is the low end for many of us), that’s over $200 a month if you only spend that during the work week. If you go out for dinner and get drinks on the weekends, it’s a lot more!
Try using coupons at the grocery store, turn off lights you aren’t using, and limit your spending money. Drive a lot? Join a loyalty program with your favorite gas station. There is no shortage of options available.
Don’t Overdo It
Of course, you want to put as many resources as possible into paying off your debt. However, there is a limit for the sake of your financial health.
Essentially, we’re saying don’t put yourself through more financial hardship to get out of financial hardship. Don’t take on more debt to alleviate your current debts, don’t starve yourself, and don’t do anything you won’t stick to.
Paying down your debt is a big commitment, so focus on doing it right the first time and stick to the timeline. Don’t burn yourself out by working too many hours and don’t make any decisions you will regret.
Also, don’t spend all of your money paying down debt. You need to have something left over as an emergency fund in case something happens, and you do need to support yourself throughout this time. Clearing debt is a fine line you need to tread, and it’s easier with help.
The best advice we can offer is to seek individual advice. Reading financial tips is a great way to start, but they are always generalized. Everybody’s financial situations and goals are entirely different, so there’s no substitute for individualized, expert opinions.
Hiring a financial advisor could be the best money you ever spend, as they can help you save a lot more than they will cost you. If you’re primarily trying to get out of debt, then credit counseling is your best bet to start!
Healthy Financial Habits to Practice
Hiring a financial advisor is the best way to ensure you are getting the right advice based on your own financial situation. However, there are generally healthy habits you can start practicing today to carry throughout your life, even after your debt is paid off.
Create a Budget
Telling someone to budget is useless if you don’t tell them how. We’ve become so accustomed to the word “budget” that it’s essentially lost all meaning.
Instead, we’re going to offer you our favorite outline for a budget, known as the 50/30/20 budget. Traditionally, this breaks your budget into wants, needs, and savings. However, we’re going to change “savings” to “debt payments” for now.
Later on, you should allocate 20% toward savings, investments, or retirement funds. However, paying off high-interest debt is more important in the short term.
Remember, it’s always best to look at your bank or credit card statements to see exactly where your money is going. No matter how good your memory is, reading it on paper is better. From there, here’s how to structure your budget.
Roughly 50% of your budget should go toward essentials like rent or mortgage payments, heat, groceries, and other recurring bills that you need to survive. Lump all of your installment debts into this category as well.
If you find that your essentials are exceeding 50% of your income, work to change that. Find ways to save money on utilities and groceries first, as these are easy to fix. If that doesn’t work, consider increasing your income or downsizing, as this could be the culprit of your debt problem.
Although, if your essentials cost under 50%, you’re in the lucky few. Don’t spend it all on wants, but instead add it to your debt payments or investments.
Your “wants” should never exceed 30%, and unfortunately for our internal hedonists, this is the one most of us need to monitor closely. Spending excessively on clothes, going out to eat, drinks at the bar, and our $4 morning coffees really add up over time.
Try only using your debit card for an entire month so you can take a hard look at your bank statement at the end. Determine how much of your income you are spending on unnecessary subscriptions and other things you want.
From there, prioritize. It’s okay to treat yourself to your favorite coffee once in a while. However, when you spend $4 every morning on coffee and an additional $4 on a food item (these are on the low end for some), that adds up to $240 every month. Small changes add up to big savings.
At least 20% of your budget should go toward investments, and paying off debt is widely considered a reasonable investment. Let’s say you manage to get your wants to 28% and your needs to 45%. In that case, 27% of your budget should go toward investments, not 35% toward your wants.
To offer a concrete example, let’s say you earn $36,000 a year after taxes and you have $10,000 in debt. Your total take-home income is $3,000 a month.
In that case, putting 20% toward your debt would be $600 each month. With a lower interest rate, you could potentially pay off your debt in a year and a half.
Although, if you manage to get up to that arbitrary 27%, it may not seem like a big difference. However, you would be spending $810 on debt every month, which could eliminate that debt in just over a year. Again, seemingly small changes add up.
Avoid Debt Spending
If you take away anything from this article, it should be to stop spending on your credit cards while trying to pay them off. Once your card is paid off, you can continue to use your credit card, but you should pay it off in full at the end of every month and manage debt appropriately.
Leaving a balance of 1% of your credit limit won’t be the end of the world, and it may help your score. However, it’s always better to play it safe to avoid digging yourself deeper into debt.
Now, if you have trouble with credit card spending, then we have a suggestion. Lock it away and throw away the key.
However, it is beneficial to your credit score to keep your credit lines open and in good standing. Because of this, we recommend leaving some recurring payments on your credit card (once it’s paid off) and paying them in full at the end of each month.
For example, leave some of your monthly subscriptions on your credit card so you still have a transaction record, but pay them off every month as you would with your debit card. This is an easy solution to prevent overspending and still boost your credit health.
Get Out and Stay Out
If you follow these tips and get out of debt, do your best to ensure that it’s permanent. We can’t anticipate everything life throws at us, as the last few years have taught us. However, we can plan for them just in case.
Stay up to date with our latest financial news and feel free to contact us with any questions!