Reducing Your Debt
So, you’ve taken time to review your budget and you’ve made cuts where you can. Now, let’s talk about how to reduce your overall debt. This is the next step toward improving your credit and financial wellness. For many Americans, financial debt is crippling. Credit cards, student loans, medical bills. You may feel completely choked. However, there are ways to improve this situation overall. Though it will take time and work, financial freedom from debt feels great.
Financial Planning Recap
Over the past few months, we have taken some time out of our usual content to discuss the benefits of financial planning and improving your budget. We at Royal Life Centers want to be a resource not just for drug and alcohol addiction rehabilitation, but for a full continuum of wellness. This includes financial wellness!
Our last conversation was about how to make cuts to your spending so that you could free up additional income for other things. There are some rules you should make sure you follow when you do this. The most important of which is:
Pay Yourself First
This means to make sure that if you are reallocating money from unimportant things, you are putting something away for savings or retirement. Depending on your financial situation, this may be a challenge. However, as you begin your journey of financial freedom from debt, even $10 a week into savings will start to add up over time. You need to be consistent and add more as you reduce more debt. If you don’t have a retirement plan from work, getting a personal one through your bank is also a great idea.
With all that being said, let’s jump right into today’s topic, as well as some tips and suggestions for how to reduce your debt.
Which Debts Affect You the Most
Debt is tricky. What is even more confusing is, different types of debt affect you differently. And by that, we mean, your credit. When you are deciding which debts to pay down first, you should always consider that which has the biggest impact on you. The biggest bang for your buck. Here we will discuss the two main types of debts and what they mean.
Revolving credit means credit cards, essentially. These are accounts with balances that can go up or down as you use and pay them. These types of debts weigh heavily on your credit report because they not only affect your debt-to-income ratio (how much debt you owe vs how much you make), but also your utilization. Basically, how much of your available credit you are using up. So, for example. If you have a credit card with a $1,000 limit and you owe $950 on it… you are at 95% utilization which has a very negative impact on your credit score. You want to focus on having 30% or less of your total credit limit utilized – so, $300 or less in our prior example.
Typically speaking, paying down credit cards is a great way to not only reduce your debt, but get more money back in your pocket, and improve your credit score. High interest rates often make this a challenge.
An installment debt is more like a loan, or car payment. You owe a set amount, and pay it down. Once it is paid down, the debt is done and the account is closed. Typically speaking, things like car loans, mortgages and student loans – while overall larger – they generally hold less negative weight, unless they are behind. Part of this is because utilization is not a factor. Also because they are “secured” loans, meaning something is tied to them (like a car or home).
Due to being secured and not impacting utilization, it is generally a better idea to work on your revolving debts first. Also, since installment debts are usually larger and harder to pay down, it may not be the best place to begin.
As a special mention, many men and women worry about medical bills. Usually these have a low impact on your overall credit. Most medical providers will also consider small and manageable repayment plans. Medical bills should be a lower priority than other debts.
Where do I begin?
Great question! That is, afterall, what you came here to learn right? So, just like with our budget, let us take a look at the various debts that you have. Make a list. Include all credit cards, all loans, including house, car and student loans and how much you owe. Also, add in their payments so you can see how much of an impact they have on your income. From here, we can start to determine what to tackle first.
Now that you have your budget and you have made some cuts AND have a list of your debts to pay down, let’s talk about reallocating the money you are saving from the cuts you’ve made.
Let’s say that you are able to save $50 a month by cutting out minor things from your budget. Your first step is to take that $50 and apply it to one of your debts, probably a lower balance credit card. The extra will offset the high interest and allow you to pay it down quickly. If, for example, your minimum payment is $50 … you are now doubling your payment! Once it is paid off, you now have $100 that you can roll over into the next bill.
Once you have paid off your credit cards, and have a substantial chunk to start allocating, it is recommended to move on to your car payment. Typically, car payments can be high, so getting it down could free up $200-$400+ each month. High interest loans are next.
A good rule of thumb is to pay down your debts in this order, if applicable:
- Credit Cards/Store Cards
- Car Loan
- Unsecured Loans
- Student Loans
- Medical Bills
As you go through your debts and re-allocate money, this order will net you a huge gain. Depending on your debts and minimum payments, by the time you’ve paid down credit cards and car payment, you could have several hundred dollars back in your pocket. Make sure you are allocating some of this toward savings, or retirement, and use the rest to pay down remaining debts!
Don’t Make New Debt!
This should be a given, but this should be stated. Once you have set yourself up with a plan of success, do not create new debts. Just because you have paid down your bills and have some extra money, does not mean that you can go on a shopping spree. The point of this is to make life easier for you! Once your cards are paid off, put them in the drawer and don’t touch them! You don’t need them unless it is an emergency. Once your car is paid off, don’t just go buy a new one. Enjoy the freedom of having no car payment!
Special Note: Past Due Debts
This is another very common question. “What should I do about past due debts?”. Typically speaking, a delinquent debt will be removed from your records around 7 years after they went past due. This time frame will RESTART if you start paying on it.
Let’s explain this more practically: If you have a past due store card that you haven’t paid in 3 years, that means it will be removed from your credit report in 4 years. If you randomly start paying on that debt 3 years after it went to collections, you have now restarted the 7 years. Also, even if you pay the bad debt off in full, it sometimes will still linger on your report as being past due, but paid in full. It is not recommended to pay off old debt that has been past due for many years. If they are newly past due (less than 6 months with no payment), prioritize that and pay it up quickly. If it’s been several years, focus on other things.
Financial wellness may be a new endeavor for you, especially if you or your loved one is in recovery or treatment. If you or someone you know is struggling, please reach out to us at (877)-RECOVERY or 877-732-6837. Our team of addiction specialists make themselves available to take your call 24 hours a day, 7 days a week. Because We Care.