When talking about debt, many people prefer to just avoid the conversation altogether for fear of shame. The reality is, if you’re in debt, you are part of the majority - as of 2019, 300 million people in the US are in debt, totaling an American Household amount of $13.21 trillion.
Read on to find out the different types of debt, how to create a plan on paying off loans, and why you should start ASAP.
Why should I pay my debt off sooner?
The most obvious reason? Interest. The longer you take to pay off debt, the more your payments are actually going to the interest and not the loan itself. Because of this, your payback amount will be guaranteed to be higher than your initial loan.
Also - the more you payoff initially, the less chance you have of paying off extra interest, and the more you’ll save in the long run. Avoiding paying the minimum balance is a sure way to guarantee you’ll pay off most the principal balance without those extra interest costs. Plus, the sooner it’s paid off, the sooner you won’t have to worry about it any more!
What types of debt are there?
There’s a decent chance you have more than one type of debt to pay - they’re not all created equal, and some are actually considered “good” debt. Here are the different types you may encounter:
Mortgage - You have to have a place to live, so this type of debt is almost unavoidable; however, if you invest smartly, you could actually make money in the long-term once you sell.
“If you buy a home for $235,000 and it appreciates 3% a year, it will be worth $485,000 when your 30-year mortgage is paid off. If it appreciates 4% a year, that initial $235,000 investment will be worth $649,000.” - Debt.org
Home Equity Loan/Line of Credit - This is a loan with a low interest rate that uses your house as collateral. You receive it as a lump sum and pay back off a certain amount each month, and it can be used to pay off high-interest credit cards. While this is a good way to keep interest rates low, you must be careful not to forget payments, as your house could be foreclosed.
School Loan - Depending on what you want to expand your knowledge on, taking out a school loan is great debt - as long as your future career can help pay if off easily. Nevertheless, acquiring a loan for school and paying it off on time is a great way to build your credit score and not feel so guilty about borrowing money, since it’s for the betterment of your future.
Small Business Loan - Most small businesses will take out a loan or ask for monetary help when first opening their doors. Much like the school loan, this will only work if your business can actually pay it off, otherwise you’ll end up owing more than what you started with.
Credit Card - While credit cards may seem appealing because they’re an immediate fix for financial woes, you end up paying big time in the long run. Some interest rates are as high as almost 20%, which means you’re paying extra on payback versus the amount you used for your initial purchase. While they can help you in a bind, credit cards can kill your credit score if you aren’t careful.
Payday Loans - Similar to a credit card, these loans are for getting you out of an immediate jam, but they come at a price.
“It’s quick and easy, but the finance charges range from $15 to $30 for every $100 borrowed. A typical two-week payday loan with $15-per-$100 fee equates to an annual percentage rate of 400%.” - Debt.org
Auto Loans - Depending on where you live, having a car may be a necessity. Be careful going into getting a loan for a car, however, because as soon as you drive it off the lot, it’s no longer worth what you paid for. You’ll be paying back a loan that doesn’t equal the value anymore.
Which One Should You Pay Off First
There are many ways you can tackle the order of your debts, from highest-interest to the smallest amount.
Paying off the debt with the highest interest rate makes sense - you don’t want to be paying more money than you have to, so wiping this one out will help combat those ridiculously high interest amounts you’re accruing the longer you leave them unpaid.
Paying off the smallest amount owed also makes sense - because it is smaller, it will get paid off more quickly. This is a great method if you find you lack motivation, because you’ll see substantial progress. Just remember, however, that those high interest loans are just going to get higher the longer they’re unpaid.
Ordering your debt repayment in terms of tax breaks can also factor into your final plan. School loans, for example, which typically have lower interest rates than credit card loans anyway, also come with a deductible on interest when filing taxes.
How to Create a Plan for Debt Repayment
You’ll need to determine:
Which debts are the highest priority based on which method from above you use (highest interest, lowest amount, or order based on tax breaks);
How much you can contribute to debt repayment each month (this will need to be done by creating a budget if you don’t already have one);
If the repayment plan you make can be sustainable in the long run, meaning it won’t put you in the red, or be too little to make a large impact.
You can, however, consider flexibility - perhaps you get a higher-paying job, or a raise, or you move to an area with a lower living cost. Any money that no longer has a job or any extra income can be accrued towards debt repayment. Just be sure to not lower this amount, and again, make sure it’s sustainable in the long run.
Once you have these steps in place, just keep monitoring, and start imagining your life without debt - because now, it will become a reality.
If you need help with debt repayment - whether you aren’t sure where to start, or you just need some encouragement - we can help. Schedule a 60-minute consultation with us today.