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How to Get Out—and Stay Out—of Debt

Early loan repayment is one of many winning strategies.

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One of the biggest obstacles to building up your savings is debt. Most people have at least a few regular repayment obligations such as a home mortgage, car payment, student loan, or credit-card balances. But every dollar that goes toward paying off your creditors is one less dollar that could be building up your savings and investment portfolio.

So how, exactly, do you turn yourself around if you find that most (or all) of your paycheck is going toward your financial liabilities?

The first step is to create a plan that outlines the total amount of debt that you owe, and which debts you decide to whittle away first. This includes setting up a budget for yourself. The next step is to stick with it until you are debt-free.

Which Debts Should You Pay Off First?

While paying off debt may be easier said than done, by following some simple steps you can start to chip away at your obligations and begin to see progress. If you have more than one debt balance, determine which of those debts are “costing” you the most in terms of added interest fees. For example, if you have a car payment and a large credit-card balance, it is likely that the interest rate on the credit-card balance is much higher than the auto-loan balance.

In terms of deciding which debts to pay off first, there are actually a couple of methods to choose from. One is commonly referred to as the “debt snowball” strategy. This entails focusing on paying off the smallest debt first while continuing to make the minimum payment on all of your other debts.

Once you have completely paid off the smallest debt, move on to focusing on the next-smallest balance, and so on. While the debt-snowball strategy will oftentimes mean that you aren’t focusing on eliminating the most “expensive” debt first, it can be very motivating to see progress when you completely wipe away a balance.

Another debt-elimination strategy is referred to as the “debt avalanche.” With this process, you focus on paying off the balance with the highest interest rate first. In doing so, you make a large payment on your most costly debt and continue to make the minimum payment on the others. Once you have paid off the most expensive balance, move on to the one with the next-highest interest rate. Repeat until all of your debts have been paid off. 

Tackling Credit-Card Balances

When you’re tackling your credit-card balances, there are different ways to reduce the amount that you owe. For example, you could contact your credit card company and request a lower interest rate. Depending on the total balance that you owe, even just a small rate reduction can be beneficial.

Also, you may be able to transfer your credit card balances to a different card that offers a zero-percent interest rate. If you go this route, though, be sure that you read all of the card’s fine print, since those low “teaser” rates will usually expire after a certain amount of time. But if you can pay off the entire balance within that time frame, this can be a viable strategy.

Smart Solutions for Student-Loan Debt

One of the most common financial burdens to carry, especially for Millennials, is student-loan debt. Nearly 70 percent of 2018 college graduates have private or federal student debt, with an average balance of $29,800. The average monthly payment on student loans is just under $400 per month, with an average payoff time of 21 years!

If you are carrying student-loan debt, one way to pay it off sooner is to pay more each month than you actually owe. For instance, by paying just an additional $50 or $100 per month, you can significantly reduce your interest cost and get your loan paid off sooner.

If you have more than one student loan, it may make sense to consolidate them so you can focus on making just one payment, rather than several, each month.

Depending on your occupation, you might even be able to have your student-loan debt forgiven. For example, if you work for a qualifying 501(c)(3) nonprofit organization for at least 30 hours per week, after 10 years your student-loan debt can be wiped away. (It is important to note that you will still need to make your monthly student-loan payments in full, and on time, through an “Income-Based Student Loan Repayment Plan” over the 10-year period.)

In other situations, such as filing for bankruptcy, you may or may not be allowed to eliminate your student-loan debt. This can depend on the type of bankruptcy that is filed. With a Chapter 13 bankruptcy, student loans are considered “non-priority unsecured debt,” meaning that you won’t be required to pay the full amount of this debt through the bankruptcy repayment plan. In the case of a Chapter 7

bankruptcy, though, in order to have your student-loan debt discharged, you may need to file a Complaint to Determine Dischargeability. But this can be a long and tedious process that typically requires you to prove you are unable to maintain a minimal standard of living, based on your financial situation. 

The Ticket to Eliminating Your Car Loan

Similar to your student loan, you can also pay off your auto loan more quickly and reduce your overall interest charges by making an additional payment each month. Even just “rounding up” can be beneficial. For instance, if your monthly payment is $281, you can round it up and pay $300.

Another method is to pay half of your monthly car payment every two weeks, as opposed to just one payment per month. Although this may sound a bit strange, by going this route your 26 “half” payments will equate to 13 full payments per year, rather than just 12.

While this strategy may only save you a small amount of interest, you will still repay the loan much faster so you can use the money that you would have earmarked for auto payments to increase your savings instead!

Making Your Home Truly Yours by Getting Rid of Your Mortgage

For most people, a home is the largest purchase they will make in their lifetime—and one that usually requires taking on a mortgage. But even though paying off a five- or six-figure mortgage may seem daunting, there are ways that you can accomplish this.

Similar to with your car loan, you could make your mortgage payments every two weeks rather once per month. This will essentially mean that you’ve made one additional monthly payment for the year, substantially reducing both your overall balance and the amount of interest that you pay. (Mortgage interest usually makes up more than half of your total loan repayment.)

You could also put any “extra” money you receive toward paying off your home mortgage. For example, if you receive a bonus at work or you get a nice tax refund, use those funds for making an additional principal
payment on your mortgage balance. Before going this route, though, you should consider putting this extra money toward “bad debt” first, such as high-interest credit cards. That’s because your home can increase in value over time, and could even become an income generator for you if you decide to convert it to a rental property. This isn’t the case with credit-card debt and other types of unsecured debt balances.

How to Stay Out of Debt

Once you’ve paid down your debt, it may be tempting to go out and make big purchases again. But that’s actually one of the worst things you can do, since it could put you right back in the red.

One of the best ways to help yourself stay out of debt, then, is to train yourself to become more disciplined when it comes to spending. This can include:

• Only allowing yourself to use a credit card in case of emergency

• Sticking to your monthly budget

• Setting up an automatic savings plan (or “paying yourself first”) so that a certain amount of money goes into an account each month. 

Getting on the Right Financial Path

While paying off debt can be somewhat challenging, it can also be extremely rewarding to get out from under financial obligations that are keeping you from building up your future savings. While there are some well-defined strategies for getting out of debt, though, everyone’s situation is different.

With that in mind, it can be beneficial to meet with a financial professional who can help you design a debt-elimination plan as well as a savings and investment plan that is right for you. Doing so can give you a step-by-step guide to follow that can help you stay on track and get your debt obligations paid off much more quickly.

This article appears in the March 2019 edition of OutSmart magazine. 

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Grace S. Yung

Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston and was recognized as a “Five-Star Wealth Manager” in the September 2017 issue of Texas Monthly.

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