Balancing debt is never easy. The monthly pay check will only go so far and how many times have you looked at the figures, wondering what to do? One of the issues that you should address is the priority with which you treat your bills. You have to live so life’s essentials must be bought but you may be spending on things that don’t remotely come under the category of essentials, especially if you are in financial trouble.
A typical family may have four or five forms of debt at varying levels of interest rate:
- Mortgage debt which though potentially large is likely to be long term and at a low rate of interest.
- Auto debt generally for a term of three to five years at market rate.
- Medical bills at 0% interest and an agreed monthly payment.
- Students loans still outstanding with fairly competitive interest rates and reasonable flexibility.
- Credit Cards which have a credit limit with a relatively high rate of interest applied to balances that are unpaid at the end of the accounting period. Each credit card company requires a minimum payment each month.
There are two schools of thought as to how to prioritize this debt. The first school of thought suggests paying off a medical bill because it is likely to be small and there will then be one less creditor. The logic is that it will boost confidence when it may be at an all-time low if debt is becoming all consuming. Psychologically something that may be seen as a small victory can provide momentum towards solving other issues.
The more popular approach is to prioritize the credit card because it is the most expensive debt that most households have. Those merely paying the minimum requirement each month will hardly reduce the balance at all once interest is added so it becomes core debt. A personal loan is much cheaper and using such a loan to pay off a credit card balance is certainly a sensible strategy.
The reality in the USA today is that households are often carrying student loan liabilities as well and although the terms and conditions of such loans are more flexible than others, debts need to be paid. Nerdwallet reports that a typical household may face:
- Student loan $50,000
- Mortgage loan $170,000
- Credit Card balance $15,000
- Auto loan $27,000
Clearly many rent their properties and therefore do not have mortgages but the real thing that stands out is the credit card problem. If psychologically one school says address the smallest figure and that means the credit card balance which can be solved by the suggestion above about $5000 loans.
It is important to address debt and maintain determination and self-discipline in doing so. Self-discipline involves not returning to spend on a credit card without clearing the balance in full when the statement comes in. By all means keep your card or cards because your credit score does benefit from having available credit which is reduced if you close the account.
If you are in financial difficulty that self-discipline also involves resisting the temptation of renewing your automobile so frequently. Autos are built to last longer than a typical loan term and simply because you may have the chance to take out another auto loan because the previous one is settled it does not mean you automatically have to do that.
The main incentive in reducing debt is that it then provides the opportunity to save more. You will want a comfortable retirement and the only way you will achieve that is by saving money to achieve that. The benefits you will be able to draw from Social Security are no more than a support in later years; they certainly cannot fund your later years.
There is no perfect solution for individuals in financial trouble. Some will want to have fewer creditors and may therefore prefer to pay off the smallest creditor first. Others will tackle debt that carries the highest rate of interest. Whatever your individual choice the main thing is to act. There is no choice if you want to reduce your level of stress and be ready for the day when you actually retire.