It’s not a secret Americans are loaded with personal debt. Even after the economic challenges of the last recession, the average American is carrying a higher debt load.
According to the Federal Reserve, total U.S. consumer debt in 2014 amounted to a staggering $11.85 trillion. That includes revolving debt, such as credit cards, and other loans like mortgages, auto loans and student loans, among others.
Not all debt is “bad debt”. Borrowing for a home, for example, or for college typically makes sense. However, it is important to try and minimize your personal debt as much as possible.
Here are some tips to help you learn how to control your personal debt and reach your financial goals.
Pay off your credit card every month
The quickest way to fall into debt is to use credit cards carelessly. Don’t use a credit card to purchase items if you aren’t able to pay off your monthly bill in full in a month or two.
Once you’ve fallen into credit card debt, it can be very hard to dig yourself out. Consider this example:
Let’s imagine you used your credit card to purchase a $5,000 vacation. Every month, your card extracts 16 percent annual interest on your outstanding balance. If you manage to pay off your vacation immediately, you will pay no interest. If you pay it off in one year, you’ll be forking over about $400 in interest. Even worse, if you take 10 years to pay it off, you’ll be paying a whopping $5,080 in interest. That’s more than you originally borrowed!
When it comes to large purchases and credit cards, it is best if you save over a period of weeks or months before charging it so that you can pay the balance when it’s due and avoid interest charges.
If you’re going to take out debt, know your options
If you plan on taking out a loan for a major purchase – perhaps a new car, tuition or a home renovation – take the time to do your research and find the best option for your situation. A standard loan may not always be the best option. For example, a home equity line of credit can often be an effective way to finance larger purchases.
Home equity loans are loans in which the lender agrees to lend a maximum amount within an agreed period (called a term), where the collateral is the borrower’s equity in his/her home. Your equity is the amount you would receive after selling a property and paying off the mortgage. (For more information, please refer to this article).
It’s up to you to find the most affordable option for your purchase!
Pay off your highest-rate debts first
If you are carrying debt, develop a repayment plan in which you pay off your highest-interest debt first, while maintaining the minimum payments on your other debts. Once the high-interest debt is paid down, tackle the next highest and so on.
Add additional payments to your mortgage
When it comes to a home mortgage, you can save a great deal of money by simply paying a little extra each month or year. There are many calculators online that allow you to determine exactly how much you will be saving, including this one on the MidWestOne website.
However, don’t use all your savings to pay off a mortgage if you have other debt. Mortgages tend to have lower interest rates than other debt, and you may deduct a portion of the interest you pay on a mortgage loan*. (If your mortgage has a high rate and you want to lower your monthly payments, consider refinancing.)
Don’t be afraid to ask for help if you need it
If you have more debt than you can manage, get help before the situation spins out of control. Last month, I discussed the importance of a “go-to” person at your financial institution. Find that person and work together to develop a repayment plan. If you want help finding a banker to talk to, I’d be happy to recommend one.
Your financial wherewithal is your responsibility. There is no time like the present to begin to strengthen your current position.
*Consult a tax advisor regarding the deductibility of interest.