It’s time to get serious. You owe someone money, and we want to pay that money back. Today’s 31 Days To Your Financial Future task is all about hitting your debt as hard as you can.
Every day that you owe someone money is a day that you aren’t entirely free.
In his novel Barry Unsworth’s historical fiction novel Sacred Hunger, a character says:
Once a man is in debt he becomes a flesh and blood form of money, a walking investment. You can do what you like with him, you can work him to death or you can sell him.
That particular passage was talking about the 18th-century slave trade, but it applies to today, too. Debt forces you to work harder just to enjoy your life. It can make you work more hours, even take a second job, and let’s face it — debt is stressful. Every day you’re in debt, interest is accruing on what you owe, and you’re paying more than you need to be. Can you be sold? Thankfully, not in the real sense — but your debt can, often to a series of increasingly aggressive and belligerent collection agencies who will stop at nothing to hunt you down and hound you for what you owe.
Debt doesn’t go away. It can’t be ignored. The only positive way to get rid of it is to pay it off, and to pay it off, you have to attack it. You have to keep hitting your debt and keep it reeling on the ropes until it succumbs and you get that final glorious statement that says “Balance Owed: $0.00″
If you have no debt — you’re awesome! Today, you can revisit one of the earlier posts on this series — maybe beef up your emergency fund, do some decluttering, or reevaluate your written plan.
For the rest of you, it’s time to go to war with your debt. Let’s get started.
Know What You Owe
We touched on this briefly on Day 1’s task about assessing your financial health, but the very first thing you need to do is to know exactly how much you owe, and to whom.
You may owe only one or two creditors — my wife and I owe two student loan providers, and one credit card company. You might also have MANY creditors — medical debt, an auto loan or mortgage, student loans, credit card debt, personal loans owed to a bank or credit union, business loans, private loans owed to a friend or family member.
Make a list of each creditor you owe, and beside each creditor’s name, list how much you owe them. Next to that amount, list the interest rate of that debt.
Once you have this list, you need to prioritize how to pay these debts. How you prioritize these debts is really up to you, but there are two general schools of thought when it comes to paying off debt:
Pay off the highest interest rate first
Pay off the lowest balance first
Paying the highest interest rate makes the most sense mathematically. Every dollar you owe at 20% interest (like many credit cards) costs you more money than every dollar you owe at 5% interest (a student loan). By focusing on the debts with the highest interest rate, you’ll pay less interest in the long run. This is the fastest, cheapest way to pay off debt.
But paying off the lowest balance has some great psychological benefits. Smaller debts can be paid off quicker and easier than larger debts, and there is a very real sense of relief that comes from completely eradicating one of your debts, and that can be a huge motivator to encourage you to tackle the next debt that much harder. If milestone victories motivate you, this method works.
Choose whichever option is best for you.
Minimums Aren’t Designed For Your Benefit
Something very important to remember — minimum payments are rarely designed for your benefit. A substantial portion of your minimum payment goes towards paying the interest that accrued on your debt since your last billing cycle, and only the leftovers get applied to your principal. That may mean that your $360 minimum payment each month actually only decreases the amount you owe by $40 or so.
In order to really chew through your balance, you need to pay more than the minimum, in any way you can.
Some types of debt, like the payment on my student loan, have fixed minimum payments. I pay the same amount on my student loan every month, no matter how much my actual balance is. As I continue to make payments, more and more of my payment gets applied to my principal.
Other types of debt, many credit cards in particular, calculate minimum payments as a percentage of the remaining balance. Be very careful about these kinds of minimum payments: as you pay down the balance, the amount of interest that accrues decreases, but your payment decreases too, which prolongs the time it takes to pay off your debt. If you do have this kind of percentage-based minimum, try to pay a fixed amount every month anyway.
Creditors love it when you pay the minimum, because it gives them more time to charge you interest, which means more money in their pocket month after month.
Every Fixed Payment You Make Accelerates The Process Of Paying Your Debt
Even if interest is eating up most of your payment, every dollar that gets applied to your principal decreases the amount of interest that will accrue over the next billing cycle. The faster your principal drops, the less interest accrues, which means a larger and larger portion of each fixed payment gets applied to your principal.
Example: If you have a large loan and a fixed minimum payment of $250 a month, interest may eat up more than half of your first few payments. Once that loan is almost paid off, though, that same $250 payment may go almost entirely to principal.
Every single thing you can do to reduce your principal accelerates this process. Some ways you can reduce your principal include increasing your monthly payment, making extra payments throughout the year, or even just throwing irregular lump sums at your debt whenever you have it available.
Getting And Staying Current
If you’ve missed some payments, it’s imperative that you try to get current on the loan. This takes priority over a debt with a higher interest rate or a smaller balance. Every missed payment can kick off a snowball of disaster, because a missed payment comes with late fees. If you’re struggling to pay your bill, those late fees make keep you from being able to pay next month’s payment, too. The problem can quickly get out of control and therein lies the path to financial ruin.
If you’re overdue on a debt payment, here’s what you do:
- Act fast. A payment that comes in a few days late usually just means a few extra fees. But a debt that hasn’t been paid in a month or more could mean a penalty to your credit score, a sudden increase in your interest rate, or the creditor may even demand that you repay the entire balance in full immediately.
- That credit score penalty can be a big deal. Your other creditors routinely check your credit rating — if they see you’ve missed a payment to someone else, that makes them worry that you might miss paying themtoo. You might end up with an interest rate increase on a debt you never failed to pay on time.
- Stay in contact. Don’t ignore your creditor — explain the situation to them, own up to the error, and approach them with a plan explaining how you’re going to fix the issue.
- Negotiate. If you need it, you may be able to negotiate a new payment plan to help you get back on your feet. The creditor may even be willing to let you skip a few payments to catch up (but those payments will be added to your balance, and you’ll have to pay them in the end). Remember, at the end of the day, the creditor just wants to get paid.
- Find some cash, quick. Try selling old junk to raise cash quickly, orworking a side gig to increase your monthly income. If possible, try to avoid borrowing this money from a friend or family member.
- Get current and stay current. Once you get current on the loan, try to stay there. If the missed payment was a matter of forgetfulness, try setting up automatic payments. If it was a matter of lack of funds, start doing some serious efforts to increase your income or decrease your expenses.
Sometimes, Consolidation Is An Option
If you owe several debts with varied interests rates, you may be able to seek a consolidation loan. This loan lumps all your loans together, so instead of paying six or seven different creditors, you only pay one. This can be easier to manage: it can bring down high interest rates from credit cards, and your total minimum payment may end up lower than the separate minimums for each of your original debts. This can be useful if you’re struggling to meet the minimum payments on each of your debts.
On the other hand, that smaller minimum payment may mean it takes you even longer to pay off your debt, and you may end up paying more in the long run. Think very carefully before consolidating your debt.
Debt consolidation isn’t a debt solution; you still need a plan for paying down the debt.
Don’t Give Up
Debt is daunting. It can take years to dig yourself out of it, and you may feel like you’re getting nowhere, especially if all you can afford right now is to make minimum payments and watch your principals drop by a drop in the bucket each month. Don’t give up. Focus on one debt at a time, and make every effort you can to increase your income and decrease your expenses, so that you can divert more and more money towards paying down your debts.
Whatever you do, don’t give up. Debt is a battle that can be won.
Tomorrow: Get Your Free Annual Credit Report
Today we talked about debt, and I mentioned the impact that delinquent payments can have on your credit score. Tomorrow, I’m going to talk about credit reports — how you can get yours absolutely free, what to look out for, and how to dispute anything fishy that might appear on it.
How are you attacking your debt?
Do you feel overwhelmed by your debt, or do you feel like you have it under control? Have you ever had to scramble to get current on a delinquent debt? Tell us about it in the comments!
Photo by Tiger Soul.