5 habits for staying out of debt
Staying out of debt lowers your stress level and improves your quality of life
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There are many ways to improve your financial health, but if you’re looking for the muscle-building equivalent of a protein shake for your finances, you’ll want to work on getting out of (bad) debt. How much debt you carry, your credit score and your debt-to-income ratio can impact everything from where you live to which employer can hire you, so it’s worth some extra thinking. That’s why we’ve put this handy guide together for you — DIY Guide to Managing Debt.
If you don’t have credit, have poor credit, or are carrying too much debt, you might be feeling a little overwhelmed. While it won’t necessarily be a fast process, the good news is that you can climb your way out. With some good planning, a critical eye, and patience, most people can improve their debt situation within two to four years.
Keep in mind that some debt may be good debt, like when you’re building credit that helps you earn creditworthiness. Bad debt is simply too much debt compared to your available credit or income.
Managing debt and your finances greatly improve every aspect of your life. Managing your debt well can help you obtain low-interest rates on loans, leases on nice apartments, and new job opportunities.
You don’t necessarily need a debt service to get out of debt. What you will need is a plan and a commitment to keeping track of your progress and choices. You may need to adjust your budget (or stick to it). If you are living paycheck to paycheck now, you may need to temporarily find a way to increase your income to make extra debt payments. (We know that’s easier said than done. Check out our easy side hustles article for some ideas.)
Should you get out of all debt? Not necessarily. Some debt can actually help your financial profile. For example, if you have a low-balance credit card that you pay off every month, it will help increase your credit score. Debt that will have the opposite effect on your credit score includes things like a credit card with a high balance that you don’t make payments on, or an upside-down vehicle loan (when you owe more than a car is worth).
Unless you are lucky enough to receive a large windfall, you’ll need a plan to get out of debt. You’ll need to create a working budget, see if you can boost your income a bit,, and figure out which debt to pay down first.
If you are working on building your credit, see our Ultimate Guide to Building Credit.
As you may expect, GenXers who are at the top of their earning potential carry the most non-mortgage debt. Young GenZers just entering the workforce hold the least amount of debt.
According to data collected by Experian, the average non-mortgage debt in 2020 was,
|Generation and Age||Average Non-Mortgage Debt|
|Gen Z, 24 and younger||$10,942|
|Millennials, ages 25-40||$27,251|
|Gen X, ages 41 to 56||$32,878|
|Boomers, ages 57-74||$25,812|
Debt can be confusing. Too much or too little debt hinders you. If you have too much debt, creditors may worry that you won’t be able to make payments if your income decreases unexpectedly. If you have carried very little debt over time and have no credit history, lenders do not know your payment habits since you do not have a history of payments for them to review.
Lenders estimate “too much debt” by comparing your debt payments to your income. Even if you are not currently trying to get a loan, keeping your income vs. debt in check will still help you in other ways, such as renting an apartment or signing up for utilities.
Overall, you should be aiming to keep your debt-to-income ratio at 35 percent or less.
Keep in mind that most property management companies will not rent to you if the rent is more than a third of your gross pay. So, if you add rent and debt payments together, you should have about 40 percent of your income available after payments to be financially fit.
Try to keep your debt-to-income ratio around 35%. To calculate your debt-to-income ratio, add up all your monthly debt payments and divide it by your monthly gross (pre-tax) income.
If you need to improve your debt to income ratio, you need to either increase your income or decrease your debt balances (or a bit of both).
No matter what you learned about finances growing up or how much money you have now, it’s a good idea to frequently examine your spending habits and why you make the decisions you do (or only have the options that you have). Maybe you plan well but unexpected emergencies throw you off course. Maybe you keep track of the big things but don’t hone in on the cumulative cost of the small stuff.
When reviewing your financial situation, you may benefit from analyzing your relationship and feelings around money. You can start by asking yourself a few simple questions,
Changing your spending habits can be difficult. You can start by creating a budget, and that budget should include paying down debt and an “allowance” for discretionary spending.
Too much debt negatively impacts your credit score. At the same time, having no debt history can also negatively impact your credit score. Confusing, huh? Creditors can’t decide on your creditworthiness if they have no data, no history, to review. The best situation is when you have carried some debt and made consistent payments over time, and that your overall total balances aren’t too high.
Financial experts recommended that you only use 30 percent of your available credit or less.
While some debt may improve your credit rating, you need to be careful. You will quickly find yourself in trouble if you acquire debt and your income changes or you lose your job. Debt payments need to be manageable even if your income changes. Building a “rainy day fund” can help you make your payments should you lose your job. Many financial specialists recommend that you save enough money to live three to six months without an income. Some of the best savings accounts even pay a bit of interest.
Is all debt treated the same? Creditors sometimes overlook some debts, such as student loans and medical bills. This is not a set-in-stone rule, but many loan companies see these types of debt as necessary rather than elective. School debt helps people earn more and medical debt is often necessitated. Medical debt is the top reason for bankruptcy. If you have school or medical debt, negotiate payment arrangements and keep making your payments to start building a good payment history.
Staying out of debt lowers your stress level and improves your quality of life
It may feel easier said than done, but one of the best ways to help you pay down debt is to take any additional earnings you make and put them directly towards any debt balances. For example, let’s say you have a credit card with a minimum required payment of $50. If you earn an extra $50 per month selling items online, you can pay $100 per month and pay down the debt twice as fast with minimal effort.
Here are some ideas to get you started:
When you begin to make “extra cash,” make sure to budget the money towards paying down debt, savings, and improving your credit. Check out these 20 ways to earn fast cash.
Do you need extra cash, like yesterday? Find easy side hustles to catch up with your bills quickly or to build your savings.
Another strategy that can help you pay down debt is to refinance or consolidate your loans. You may need good credit (or show improving credit) to do this, but it’s definitely worth taking a look to see if you can get lower interest rates and lower monthly payments.
Some people benefit from refinancing student loans. Typically federal loans have low interest rates, but private loans may have a higher interest rate. Federal student loans range from 2.75% to 5.30%. Private loans often range from 3.34% to 12.99%, according to CNBC Select. If your student loan interest rate is high, you may be able to refinance your student loan at a lower rate.
If your car loan has a high interest rate and your credit is good, you may be able to refinance your auto loan. Some dealers offer loans when you buy a car, but they come with high interest rates of over 15 percent. The average interest rate is around five percent. If your interest rate is high and you are not upside-down on your loan, you may be able to find a lower interest rate and lower your monthly payment with a new loan.
A debt consolidation loan is a loan that is used to pay off multiple debts. This type of loan is often a personal loan. To be beneficial for your credit situation, you’ll need to ensure that:
There are four common methods for paying down credit card debt. These four debt repayment methods include snowball, avalanche, balance transfer, and personal loan.
Before creating a payment plan, you may want to make an agreement with yourself. That agreement outlines how you will use your credit moving forward. You may decide to quit using your credit cards until they are paid. Or, you may decide to carefully use a rewards card that you pay off every month.
To start, create a spreadsheet for tracking your debt information. Log in to your accounts and record your balances and interest rates. You will use this information to help you create the best repayment plan.
Snowball method: Using this method, you pay off the lowest balance first while making the minimum payment on the others. Some like this method because they feel motivated by getting a quicker “reward.”
Avalanche method: The repayment method requires you to make minimum payments on all credit lines while paying the highest interest debt first. This method requires more patience than the snowball method but results in paying less interest.
Zero balance: You may obtain a zero or low-interest credit card with good credit that you can use to pay high-interest debts. Using this method, you’ll want to make sure you can pay the balance before the zero balance period expires.
Personal loan: Those with good credit may acquire a personal loan with a low interest rate to pay off debt. This is a money-saving method if you are disciplined.
Whichever repayment method you choose, make sure to create a plan you can stick with and avoid adding to your debt during the process. If you receive “extra” money, such as a tax refund or overtime pay, plan on how you will utilize that money. Some choose to divide extra money into savings, debt payment, or to purchase an item on their want or need list.
Using cash advances to pay off a looming debt payment can often end up costing you a lot more than you anticipated. While some newer products have emerged on the market, traditional cash advances typically carry lots of fees and very high-interest rates. Before using a cash advance service, you need to figure out if you really can afford to pay the loan back in time and if you have any other options you can leverage first.
Payday loans are small, high-interest loans meant to be repaid when the borrower gets their next paycheck. Loans usually last just a week or two. This type of loan shouldn’t be used unless you can pay it back within a week or so in full. If it’s an option, paying a late fee or overdraft charge is often better than getting a payday loan.
|Easy to qualify||Short loan terms|
|Online and local locations||Penalty fees|
Financial services such as Varo and Chime offer this service. A paycheck cash advance allows you to access money from your next paycheck. When you are paid, you pay the loan back. These services are low-cost, but the loans are also small.
|Low priced||Small loans|
|Apply via an app||Less take-home pay|
|Requires direct deposit||Not immediate|
Needing a cash advance can be bypassed by building savings. If you live paycheck to paycheck, even a minor issue such as a car repair or vet bill can be a problem. You can avoid loans by building savings by earning more, selling items, or spending less. When you create your budget, include a plan for building up your emergency fund.
Many renters lose money that they could be putting towards paying off debt instead. Some apartments wrap optional or incidental services into your rent payment. Sometimes this is a great way to save money or enjoy extra convenience. Sometimes you may end up paying for things you don’t need.
When reviewing your lease, look for additional fees that you may be charged. For example,
If you are confused about how to manage your debt or are having a hard time feeling optimistic or in control of your financial future, it is okay to reach out for help. You may choose to DIY and educate yourself about personal finance or you may decide to hire a professional for help.
Similar to other types of stressful events, high levels of financial stress can significantly impact your ability to focus and your mental and physical health.
And if you feel anxious, distracted, and uncertain about money stuff, you’re not alone. According to some financial studies, around 60 percent of adults feel anxious when thinking about personal finances. One of the first steps towards overcoming financial anxiety is to read up and increase what experts call your “financial literacy”. Because money stress is such a universal experience, there’s lots of great content out there, including:
While hiring financial help may be beneficial, it can be quite costly, even further increasing your stress. If your budget is limited, start by self-educating. (There are also a number of non-profit organizations that can help you map out a strategy. Do some web searches to see what kind of organizations might offer programs near you.). Traditionally financial professionals and advisors charge $100-$400 an hour. A number of new credit help companies have entered the market like Credit People and Dovly. Check out our handy dandy comparison of credit help products and services — including a summary of how they work and how much they cost.
With a bit of knowledge and commitment, you can make significant improvements to your credit score in less than a year’s time.
No matter your current financial situation, you can take steps to make it look more like what you want. You may be able to alter some of your spending habits, build up a rainy day fund, pay down debt, create a credit history, earn a pay raise, or even work a side hustle.
To help you along the way, follow the basic credit building and debt repayment tips and find financial information resources to further build up your financial know-how. Good credit impacts every aspect of your life, including where you live, work, and mental health, so it is worth working on.
Unsecured debt is debt not secured with collateral. Common types of unsecured debt include credit cards and store cards. Secured loans may be secured by assets such as a home or car that can be repossessed if the borrower defaults on the loan agreement.
In 2020, the average student loan debt exceeded $35,000 per borrower. Over 50 percent of students utilized student loans.
Whether it is better to buy or lease a car depends on your financial situation. If you have poor credit, you’ll save money by skipping interest loans and lease payments by paying cash for a vehicle. If you have good credit and a high income, you may enjoy the carefreeness of leasing a vehicle.
A debt collector is a debt recovery agency. The lender often hires them to recover a debt owed. Some buy low-priced debt and pursue payments to recoup the investment. Debt collectors are limited by state and local laws regarding how long they can sue you to collect the debt.
Most debt collectors can not garnish government payments. Usually, payments can be seized for default student loans, but student loan payments are currently deferred.
If you default on your debt, the lender may “write the debt off “as a loss. Even though the lender closes your account and writes off the debt, they can still sell the debt to a collector or pursue the balance themselves. It takes about six months of nonpayment for the lender to charge off a debt.
It is discouraging to pay off a debt only to be rewarded with a lower credit score. This happens for a few reasons. One, you are no longer making installment payments. Two, if you closed a credit account, your available credit balance may have dropped, increasing utilization. Or, if you closed an older account, the average age of your accounts may be lower. Don’t worry, it usually levels off quickly once the overall debt owed is recognized.
Check out these additional resources to help you meet your renting goals.
Find low-cost banking accounts with no fees and mobile apps. Many require no minimum balance and do not charge overdraft fees.
Your credit score impacts every aspect of your life. Find out how.
While savings accounts do not pay high interest rates these days, you can maximize your savings by carrying a balance within an interest-yielding savings account.
If you have a lot of medical debt that you cannot pay back, it may benefit you to explore bankruptcy options.
You may be wondering what a credit score is? And, why is it so important?
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