If you are burdened by debt, you’re not alone.
Household debt has been rising unstoppably for more than 19 quarters. The average household in the US now has roughly $38,000 in debt. This figure excludes home mortgages.
Shouldering high levels of debt is has a number of negative effects. It reduces or eradicates one’s ability to save, can keep you trapped in a cycle of creating more debt, and impacts mental wellbeing and quality of life.
Fortunately, no matter how much debt you have, there are ways to reach the point where you have zero debts. From there, you can start building up your financial stability.
Before you embark on the road to eradicating debt, you need to understand the basic process for reaching no debt territory. Read on to learn about the essential components of the debt squashing process.
Analyzing Your Expenses
The first step to getting your finances in order and working towards zero debts is to analyze your expenses.
According to reports, the average American spends $18,000 per year on non-essentials. These include things like eating out, buying lunch, bottled water, coffee, personal grooming, impulse buys, takeout, drinks, cable and streaming services, and subscriptions.
Of course, there will be times when you need to buy a bottle of water, pick up lunch, or grab takeout. However, if you are trying to eliminate debt, keeping these expenses to a bare minimum will go a long way to freeing up funds.
To systematically slash your expenses, the best thing to do is to create a budget. One of the benefits of creating a budget is you will get a clear idea of what your expenses are.
Take a hard look at these. What can you do without?
If there are some non-essentials that you have a hard time parting with, try one month without them. At the end of the month, you might realize that you hardly even missed that online subscription or that expensive gym membership.
Earning More Than You Spend
The next step in gearing your finances towards a zero debt goal is to make sure that you earn more than you spend.
By creating a budget and cutting down on non-essentials, you may already be able to achieve this. However, in some cases, you might still be in a situation where your monthly income is barely meeting your expenses and debt payments.
In this case, you need to look at ways to maximize your income. Reducing debt doesn’t always have to be only about spending less. Earning more can also be a valuable strategy for beating debt.
Of course, earning more money isn’t always as simple as one-two-three. However, here are some ideas to get started.
First up, you can consider asking for a raise. Of course, if you have just started a job, this won’t be appropriate. However, if you have been in your job for some time, and are hardworking and diligent, there is no shame in asking for a raise.
Another option is to look into taking on a second job. Side hustles can also be a good idea. Things like uber driving, pet sitting, renting out your garage, etc., can all help you earn a little extra income.
Prioritizing the Most Important Payments
Another essential part of the process of achieving zero debt is knowing what payments to prioritize.
In many cases, even by eradicating non-essential expenses and maximizing your income, you still might not have enough money to make all of your payments for some months.
If you find yourself in a situation where you need to juggle different debt payments, you need to know which ones to prioritize. The rule of thumb is to never pay an unsecured debt before secured debts.
For example, if you have a mortgage (secured debt) and a credit card (unsecured credit debt), you should prioritize your mortgage payments. If you default on your mortgage, you could lose your house and all the money that you have put into it.
On the other hand, if you fail to make a payment on your card, this will probably only affect your credit rating.
Another way to prioritize payments is by interest rates. If you have enough money to make all your payments, and some extra, then pick the debt with the highest interest rate and put the additional money towards that.
Prioritizing debts with the highest interest rates will save you money, as the quicker you squash those debts, the less interest you will have to fork out.
Once you have reached a point of no debt, there is another important payment that you need to prioritize to build financial health. This is your savings payment.
Commonly known as “paying yourself first,” prioritizing savings payments is essential for ensuring that you won’t be forced back into debt by unforeseen circumstances.
Understanding the Difference Between Good and Bad Debt
There is a common conception that all debt is bad. Technically, this is not true.
In many cases, taking out credit can allow you to do things you wouldn’t otherwise be able to, such as buying a home, gaining a degree, or starting a business. These types of debt are often viewed as productive debt.
The idea is that this debt can allow you to buy things that will provide a return. In the case of a home, instead of paying somebody else to rent, you will be investing in your own property, which is an asset. Higher education can secure you a better income, and investing in a business can bring you returns.
On the other hand, some types of debt are notoriously unproductive. These are consumer debts and include things like credit cards. Consumer debt is all debt that is created by buying consumable items on credit. These are items that are not assets and won’t appreciate.
Once you understand the differences between good and bad debt, you can then focus on eradicating non-productive debt first, and then work on paying off any productive debt you might have.
The Importance of Debt Restructuring
If you are on a mission to reach a point of no debt, you also need to know about debt restructuring. This technique is also known as debt consolidation and can be an effective component of a successful debt eradication plan.
Debt restructuring is the process of refinancing your old debts with a new one. The goal here is to simplify your debts and hopefully gain a reduced rate of interest.
If you have a decent credit score, there is a good chance that you may be able to secure a solution with lower interest rates than the average rate across your debts.
For example, say you have three debts, with interest rates of 18, 17.5, and 21 percent. The average rate of interest on your debt would be calculated as follows:
18+17.5+21=56
The average rate of interest = 56 ÷ 3 (the number of loans you have) = 18.3 percent
In this case, if you were able to secure a financing solution that would allow you to consolidate your debt at an interest rate of 16 percent, you would be able to save substantially in interest payments.
You might be wondering, “why would I be able to get a better interest rate than what I have now?” In some circumstances, your credit rating may have changed. In others, you may be able to swap high-interest type debt (such as credit card debt) with a type of debt that attracts lower interest rates, such as a personal loan.
If some of your debt was taken out when you were younger, this would typically have higher rates of interest. Since then, your credit score has probably improved, which means you may be able to refinance for a better rate.
Let’s now take a look at two of the main ways you can consolidate your debt.
Debt Consolidation Options
One of the best ways to consolidate debt is through a personal loan. Personal loans typically attract relatively fair rates of interest, providing that your credit score is in good shape.
Once you take out the loan, you can use the capital to pay off your existing debts in one go. Once this is done, you will just be left with the payments on the personal loan.
If you mainly have credit card debt, you can also choose to consolidate this using a balance transfer card. Balance transfer cards allow you to shift your existing balances. This usually invokes a fee.
However, depending on the card, you may be entitled to low or zero rates of interest for an initial period. This period can be anything from 12 to 24 months.
During this time, you have the opportunity to pay off the card at a reduced or 0% rate of interest. This will allow you to pay off the amount faster, as money that would have gone to interest can now go to the loan amount.
Take note, however, that once the initial grace period ends, you will generally be charged standard credit card rates on the balance that is left on the card. Ideally, you should aim to get all of the debt paid off before this happens.
When to Seek Debt Assistance
In some cases, it may feel like no matter what you do; you can’t seem to get out from under your debt.
If you feel unable to meet your payments, there are a few options you can consider. The first step you should take is to seek credit counseling. From there, you can look into ways to achieve debt forgiveness. If all else fails, you can also file for bankruptcy.
Credit Counseling
Credit counseling can be invaluable, especially if your emotions are clouding your judgment around your debts. If you can’t think logically about your debts and feel panicky, it can help to sit down with a counselor who can discuss the situation calmly.
If you feel that you need this, there are several non-profit agencies that provide debt counseling.
Debt Forgiveness
If you are unable to meet your debts, you can also look into seeking debt forgiveness.
One way to seek forgiveness from creditors is to simply call them up, tell them your situation, outline what portion of the debt you can pay, and over what time. In some cases, you may find that the creditor accepts your offer, and a portion of your debt will be written off.
However, successfully working work with hardened creditors usually requires some experience. If you don’t feel like handling this, you can engage a company that specializes in debt reduction services.
They will then work with creditors on your behalf for a fee, or for a cut of the forgiven debt.
Filing for Bankruptcy
A final option that you can choose is to file for bankruptcy. This is usually only recommended if your debts are utterly unmanageable, or you have no income.
Filing for bankruptcy will erase certain types of debts, such as credit card debt and personal loans.
Taking this route will, however, crash your credit score. This can make it hard to find employment and take out lease agreements. You also won’t be able to access any kind of credit for seven to 10 years.
Want to Get to Zero Debts? Start Here
True fact: if you have $10 and no debts, you are wealthier than 15 percent of American households combined.
Reaching a place of zero debts take hard work, but it is achievable. With no debt to hold you back each month, you can begin building wealth.
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