Personal debt is becoming a greater problem, with over 51% of Americans carrying a balance- and paying unnecessary interest- on a credit card in the last year. According to the same study, "Financial Capability in the United States" by the FINRA Investor Education Foundation, over a quarter of people paid only the minimum payment on some months.
Lack of consumer knowledge about carrying a debt and lack of confidence about one's ability to pay off their debt help contribute to the problem. However, with proper knowledge, a good plan, and determination, anyone can become debt free.
Reasons Not to Carry Debt
Carrying debt has become the norm among Americans, with few consumers realizing how costly it can be in the long-term. If a person has a mere $1,000 on a credit card, doesn't charge another cent, but only pays the minimum (18% interest plus 1% of balance), it will take them 113 months to pay off their debt and they will pay $923.12 in interest alone.
Payday loans, which about 1 in 20 people a year take advantage of, have even worse interest rates. The various fees associated with debt also add up very quickly. Bankrate.com has a credit card calculator available to see exactly how long it takes to pay off debt and how much is spent on interest.
Carrying debt in any form, except perhaps with a mortgage, is counter-productive and hurtful. The standard excuse "I'm doing it to improve my credit rating" is not valid. The rules of how much debt to carry, what kinds of debt to carry, the debt to limit ratio, and how long to have it are so complicated that very few individuals actually improve their credit rating by carrying debt. And any improvement in their credit rating is often negated by lost money spent on interest.
Determining Personal Debt
The first step in getting out of debt is determining, to the very last cent, how much money is owed to various entities. A simple spreadsheet- or even a piece of paper with lines drawn down it- is all that is required.
Debt should be listed from the most owed down to the least owed. In other columns, include the current interest rate being paid, who the money is owed to, and any specific details that are important- such as an increasing interest rate. Determining debt is vital to developing a plan to get out debt.
Considering Other Options
While paying off debt is always the responsible and most beneficial choice, this might not be practical for a small percentage of people. One option these people can consider is bankruptcy. There are various types of bankruptcy individuals can file for, including Chapter 7 (straight liquidation of assets to pay for debts), Chapter 11 (for individuals with businesses), and Chapter 13 (a trustee deals with creditors to work out repayment terms and methods). Bankruptcy should be a last-resort.
Another option is debt consolidation. While this can be a good option, allowing the consumer to lower the total amount they are required to pay and simplifying repayments, it often negatively affects the credit score. A good portion of money that should have gone to pay creditors often gets spent on the debt consolidation services themselves.
Paying Off Debt: "Snowballing" Payments
For individuals, the most beneficial- in the long run- method of dealing with debt is to simply pay it off. A simple four part plan is sufficient.
- Stop increasing debt. Pay for everything with cash and do not increase existing debt.
- Organize debt. For many individuals, there is little organizing to do. While many companies offer a lower interest rate, the transfer fee often wipes out any savings. If a lower interest bank loan or lower interest credit card is used, it is important to use the money to actually pay off debt.
- Put all available money towards debt. Increase income if possible with a part-time job or by working longer hours. Cut spending as much as possible, and put all extra money towards existing debt.
- Start with the smallest debt. Pay minimum on the larger debts and pay off the smallest debt as fast as possible. Once the smallest is paid off, "snowball" the extra money into the next smallest debt. Pay off and then work on the next one of the list. As each debt is paid off, the extra money goes onto the next one, the money going towards debt growing over time, hence the term "snowballing."
Paying Off Debt is an Investment in the Future
Becoming debt free sometimes seems to be an impossible task. Paying off debt and maintaining a debt-free lifestyle are vital to financial well-being later in life. Not only is money no longer wasted on interest and other fees, the extra money can now be put towards paying off a house, funding a retirement plan, or saving for a child's college education. Paying off debt not only saves money and improves life in the short term; it is an investment in the future.
Sources:
- Bankrate, Inc. (2010). Credit Card Calculator.
- FINRA Investor Education Foundation. (2009). "Financial Capability in the United States- National Survey, Executive Summary."
- United States Courts on behalf of Federal Judiciary. "Bankruptcy Basics."
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