Developing a personal debt management strategy is essential. People have many debts and different overall financial challenges they are trying to manage. These challenges may include paying off high-interest-rate debt, decreasing spending, increasing income sources, or saving more money.
There are different types of debt, and some are easier to pay off than others. Here are the four main types of debt you may have: unsecured, secured, installment, and revolving. These terms refer to loans and active lines of credit through your bank or other financial institutions.
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What is Personal Debt?
Personal debt is defined as any money you owe that isn’t related to business or professional activities. It includes credit card debt, student loans, and medical bills.
Here’s a list of items that are considered personal debt:
- Credit card debt
- Payday loans
- Student loans
- Mortgages and home equity loans
- Car loans
- Medical bills
How Much Personal Debt is Acceptable?
When figuring out how much debt is too much, most financial experts say you should not owe more than 36% of your total income. The debt-to-income ratio is one of the first things lenders look at when determining creditworthiness. If your debt ratio is 40% or above, you have too much debt and should consider trying to lower it.
According to the Consumer Financial Protection Bureau (CFPB), here are some questions that can help you figure out whether your debt is manageable:
- How much do I owe?
- What kind of interest rate am I paying?
- Can I afford my monthly payments?
Is There a “Good” Kind of Debt?
Most people think of personal debt as a bad thing. But if you’re going to live in the real world, you need to know how to get out of debt and how much personal debt is acceptable.
Living in a home, using public utilities, and driving a car open you to a certain amount of personal debt. But you can decide how much and when to lower or reduce that debt to meet your expenses.
If you have high-interest debt, such as credit card balances or payday loans, it’s a good idea to pay off these accounts as soon as possible. Paying off high-interest debt can save you hundreds or thousands of dollars in interest payments over the life of the loan.
How to Get Out of Debt?
The first step in getting out of debt is figuring out how much you owe. It might be a good idea to make a list of all your debts and the interest rates associated with them. Next, add up the total interest rate for each debt.
If you’re paying more than 6 percent on any loan, it’s time to look for another way to finance the purchase — or find another way out of debt. Here are steps to reduce your debt and keep more money in your retirement account.
1. Know what kind of debt you have
Ensure you know exactly what kind of debt you have and how much it costs. You can do this by looking at your credit card statements or calling the customer service number on the back of your card.
Once you know what kind of debt you have, start putting it all together in one place so that you can see the big picture. This will help you determine what needs to be paid off first, which ones cost the most, and how much interest is charged on each debt piece.
2. Set a goal and commit to it
A clear idea of where you want to be in five years, 10 years, or 20 years will help you make the best decisions for your financial future.
Even if your goal is not to be wholly debt-free but to reduce your debt by $10,000 or $20,000 in five years, that’s still a good start. Setting concrete goals will help keep you motivated and focused on the task.
Make a plan for achieving your goals and stick with it no matter what happens.
3. Create an emergency fund
To save money and pay down your debt quickly, you must set up an emergency fund in case things go wrong — like losing your job or having a medical emergency — so that you won’t have to rely on credit cards when an unexpected expense arises.
4. Cut back on expenses
Cutting back on expenses is one of the most effective ways to reduce debt. But it’s not easy. You need to find ways to save money without compromising your lifestyle. Here are some tips:
Start by eliminating all unnecessary expenses from your budget — cable TV, gym memberships, eating out, etc., and then move on to bigger things like buying new clothes when needed instead of replacing them when they’re worn out or giving up expensive hobbies such as skiing or golfing if they aren’t essential for you anymore.
Get rid of credit cards if possible and live only on cash. Try using cash for all purchases over $20, so you won’t spend more than what’s in your wallet at any moment. By doing this, you’ll avoid spending more than what’s in your bank account and will be forced to think twice before buying anything.
5. Increase your income
Many people who are in debt have not increased their income even though their expenses have increased over time. Increasing income may be as simple as getting a higher-paying job or working more hours at your current job.
Your goal should be to increase your monthly income by 10 percent or more until you’ve paid off all your debts. While you’re at it, you should also increase your savings rate. While this isn’t quite as simple as increasing your income, it can still be done relatively quickly if you’re willing to make some sacrifices.
6. Pay off the credit cards with the highest interest rates first
It’s essential to focus on getting rid of one type of debt before moving on to another. For example, if you have several credit cards with high interest rates, it makes sense to pay off those first before focusing on other types of debt like mortgages or student loans. This will give you more breathing room and allow you to save money for emergencies and unexpected expenses instead of using credit cards for even minor purchases like groceries or gas.
7. Refinance a debt
Refinancing a debt is another strategy to help you get out of debt. Refinancing a loan allows you to pay off an existing loan with a new one at a lower interest rate. Refinancing can be complicated but worth it if you pay high-interest rates on credit cards or student loans.
It may seem silly to borrow more money to get out of debt, but if the interest rate is lower to refinance, then you’re saving money on the interest you would be paying over the life of the loan. Plus, you would use that money to pay off your higher-interest loans, freeing up more money to pay off debt.
8. Use bonus or windfall money to pay down debt faster
If you get a bonus at work or receive an inheritance, your first instinct might be to treat yourself to something nice. But if you have high-interest debt, using this money to accelerate your debt reduction plan can make sense.
If you have a credit card balance of $5,000 and you put $2,500 toward it, that’s $500 in saved interest payments every year. And if you pay off the balance in two years instead of three, that’s an extra year of lower payments and one less time when the balance will be accruing interest (and thus getting bigger).
9. Make extra payments on your loans
If possible, consider making extra payments towards your loans. By paying more than the minimum payment due each month, you’ll reduce the interest that accrues and save money in the long run (and get out of debt faster).
The only downside is that this method requires more money upfront, which might be impossible if your income is low or unstable. Check with your lender to see if they offer this option before paying extra by calling them directly or visiting their website.
10. Don’t forget to pay yourself
One of the biggest mistakes people make when trying to save money is restricting their budget too much. It can get pretty depressing to save every dime of income you get every month to pay off debt.
If your budget is too strict, you won’t stick to it and will fail. Pay yourself something out of each paycheck, even if that is just a cup of coffee at Starbucks every morning on the way to work. It’s a little pat on the back for being vigilant about controlling your finances.
Final Thoughts on How to Get Out of Personal Debt
Debt is a tough thing to deal with. The good news is that, in most cases, debt can be managed. You need to know where to start.