5 Steps towards Getting out of Debt
Consumer debt in the United States is at an all-time high. According to Experian, America's consumer debt reached $14.1 trillion at the end of 2019. That is a 19% increase over the last 10 years. Student loans, auto loans, and retail cards increased the most out of all debt types. And the generation that saw the highest individual debt increase was millennials, who reached an average personal debt of over $78,000.
If you're one of the many people who currently struggle with credit card debt, student loan debt, or something else entirely, it may seem like there is no end in sight. However, with some proper planning and budgeting, you can begin to work your debt back down to zero. We've gathered some simple ways you can start to take control of your finances and begin to change your financial future for the better. Let’s start by understanding more about debt.
What Is Consumer Debt?
While there are many different kinds of debt, the average American is most affected by consumer debt. The simplest way to explain consumer debt is debt taken on voluntarily by individuals to pay for things that are not typically considered a business or government investment. This means that tax debt and medical debt are not included. Business loans and liens on commercial properties are also examples of debt that is not considered consumer debt.
Most Common Sources
The most common forms of consumer debt for Americans include the following:
- Credit cards
- Retail cards
- Payday loans
- Auto loans
- Student loan debt
- Mortgages and home loans
- Unsecured personal loans
With a better understanding of what consumer debt is, let’s begin exploring ways to start getting back to a level financial playing field.
5 Steps to Getting Your Debt under Control
If you are shouldering any of the forms of debt listed above, you are likely wondering what you can do. While getting out of debt is not easy, it is possible. Here are 5 things you can do to start working towards paying off your consumer debts.
Step 1: Calculate Your Total Debts
Begin by assessing your debt. Gather all your loans and credit card statements. Write down the balance, interest rate, and minimum payment for each one. Also, work to order your bills according to both highest interest rate and outstanding balance.
Step 2: Lower Your Interest Rates and Payments Where Possible
Contact your creditors and request a lower interest rate on your loans. Many creditors are willing to work with you, if you have had good payment history and explain some type of financial hardship. If they aren’t willing to consider this, you can always consider taking other steps. Refinancing your home or car payments with another lender or transferring your credit card balance to a new credit card with a lower interest rate can help. Obtaining lower interest rates will almost always lower your payments unless you are also shortening the terms of your loan.
Step 3: Create a Budget and Determine What You Can Pay
Evaluate your personal budget to determine how much money you can afford to allocate towards your monthly debt payoff plan. Compare your net income against your monthly expenses (e.g., housing, utilities, loan payments, food, and clothing). Any funds you have leftover can be used to reduce your debt and save.
Step 4: Choose a Repayment Plan
Once you truly understand exactly what your total debt amounts to, it’s time to start paying it down. When it comes to repayment plans, there are many options. The one you choose will likely depend on your current income, how much debt you have occurred, and other financial obligations. Let’s start by comparing some of the most common options.
When following the debt avalanche approach, you make the minimum payments on all debts except the one with the highest interest rate. All extra money is allocated to the highest interest debt until it is paid off. Once the first balance is paid in full, the cycle repeats until all outstanding debts are paid — continuing from the highest interest rate down to the lowest. This method will often result in the most savings over the life of your loans, because you’ll end up paying less in interest.
A debt snowball is similar to the debt avalanche, except instead of starting with the highest interest rate, people are advised to pay extra towards their loan with the smallest amount first. Once the debt with the lowest amount is paid, you move onto the next smallest until all outstanding debts are reconciled. This method is great if you’ve been struggling to see a change in your debt, and it can help motivate you to keep paying it off.
Consumer Credit Counseling
Consumer credit counseling is a service provided nonprofit organizations to help people get out of debt. If you choose this route, it will be noted on your credit report. You will also be placed on a debt management plan (DMP), which stops you from using credit cards. These services can help negotiate your rates and create a budget, but counseling is not a quick process and may take years to complete. We do not recommend this type of service, though, if you have another resource you might be able to use.
Consolidating Your Debt
If you have multiple loans out, taking out a personal loan to pay them off at once may be able to help you save in the long run and pay off your debts more quickly. It also allows you to make only one monthly payment instead of one payment towards each outstanding loan. Consolidating your debts in this way may help you lower your overall interest rate, and it can make your repayment schedule more comfortable to manage. However, you may need a good credit score to qualify or will need to place your home or other assets against the loan to secure it.
Chapter 7 Bankruptcy
While not ideal, chapter 7 bankruptcy is one option for debt relief. Filing for bankruptcy can be a long legal process that requires many steps. You would need to prove you do not have the money to pay off your debts before your debts can be legally wiped away. You may also be required to give up assets to pay off outstanding debts. On top of that, not all debts can be erased with chapter 7 bankruptcy, including child support, tax debts, and student loans. We consider this a last resort.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy has some similarities to chapter 7. The main difference is that chapter 13 is considered more of a reorganization of debts. Debtors are asked to create repayment plans and follow them for three to five years, at which time outstanding debts will be forgiven. Chapter 13 may also allow people to keep their assets, such as their home.
Step 5: Keep Going!
Regardless of how you choose to get out of debt, the most important thing is that you stick to it. Since paying everything back at once is not possible for most, getting out of debt requires patience as you chip away at it. Each payment is helping you get closer to paying off your debts, so don't get discouraged as you go. Debt repayment is a marathon, not a sprint, so keep going!
Benefits of Getting out of Debt
Becoming debt free will probably require some sacrifices. However, there is a payoff when it is over. Being debt free has many advantages. With fewer monthly payments, you’ll be able to enjoy benefits like these:
- More disposable income
- Ability to save more
- Freedom to invest in your future
- Greater bandwidth for charitable giving
- Higher credit score
How do you plan to enjoy your newfound financial freedom?