Over the last two weeks, Powercat Financial Counseling has been providing you with some useful financial tips on how to better manage your money. So far, we have discussed the importance of having financial goals and why people should integrate budgeting into their everyday lives. This time, we are going to talk about debt management as a necessary step for your overall financial success.
Borrowing money and having debt are a part of life. And, for the most part, debt is unavoidable. For many people, obtaining a quality education and purchasing your first house would be a daunting task without some kind of debt. In fact, capitalism was built on the extension of credit. Responsible borrowing to a very large extent is what drives the economy; higher spending leads to the creation of more jobs and higher incomes, which in turn is correlated with higher spending.
As you can see, debt can be our friend, but it can also get us in trouble. As of December 2014, total consumer debt in the U.S. is $11.7 trillion. (eg. mortgages, credit card debt, student loans, etc.). Debt can be problematic when it used to buy unnecessary things we don’t really need, and especially when we don’t have enough income to cover our debt expenses. Debt requires a degree of self-control to avoid getting caught in the debt cycle that can last a lifetime if you are not careful.
Know How Much and Know Who You Owe
Start off by making a list of all of your debts. This list needs to include all of the creditors, total amount of the debt, due dates, and what your monthly payments are. One easy way to confirm the debts on your list is to get free credit report from www.annualcreditreport.com. You can select a free credit report from each of the 3 credit bureaus once a year (TransUnion, Equifax, and Experian). Pulling free credit reports periodically will also ensure that there aren’t any unknown debt charges under your name.
When To Stay Away From Debt
Stay away from compulsive buying. Avoid financing a long term asset, such as a home or even a car, with a short term loan from your credit card company. The value of your home or your car will not benefit you when paying your monthly credit card bill. Moreover, borrowing long-term for a short term asset such as a home appliance can get you in trouble as well. If you take a 10-year loan to buy a brand new computer with extremely low monthly payments, you will still be paying long after the computer is obsolete.
The crucial step is to pay all of your bills on time. Late payments make it harder to pay off your debt and you will be charged with a late fee. If you miss multiple payments in a row, your interest rate and finance charges will increase while your credit score will be negatively affected for up to 7 years. To make sure you are not missing payments, use a calendar system on your computer or smartphone. You can also set an alert several days before your payment is due or you can even have automatic payments withdrawn from your account so that you are never late on payments (but be sure to have enough in the bank to cover the payment). In case you miss a payment, don’t wait to pay outstanding charges until the next due date; rather, pay as soon as possible to avoid ‘missing payment’ reports to the credit bureaus. As a matter of fact, 35% of your credit score is determined by your ability to pay bills on time.
Pay More and Know Which Debt to Target First
Logically, your goal is to pay off all of your debts as quickly as possible. In order to speed up the debt repayment process, you can pay more than the minimum payment every month! Time value of money is a very powerful concept. Paying just the minimum payment on your credit card won’t get you very far and you will be mostly paying your interest cost while the loan balance won’t change much. For example, if you have a $1,000 credit card balance at 18% interest rate and you pay just the minimum each month (assuming minimum is 2% of your credit balance), it will take you over 7 year to pay off $1000 credit card balance and you will end up paying $1865 ($1000 balance and $865 in interest). If you have multiple loans, paying off the loan with the highest interest rate first would be your priority, while the rest of your debt would be paid in descending order in terms of interest rates. Paying off the loan or credit card with the higher interest rate would be a wise choice because you will be paying less in total interest on your debt. Some financial gurus even suggest to pay off smaller debts first which will drive your motivation to take care of any other outstanding debts you might have.
Understand Interest Rate Risk
Every time you borrow money, the bank will charge you an interest rate. In simple terms, interest is the cost of using someone else’s money. If you are a borrower, it is in your own best interest to get the lowest interest rate possible. Every time you are borrowing, it is crucial to understand the interest rate risk associated with the borrowing and to understand the interest rate environment. There are variable interest rates and fixed interest rates. Variable interest rates will change and its movement will depend on market forces while fixed interest rates will stay put for the life of the loan. If you are borrowing at a variable interest rate right now and you are expecting interest rates to rise in the near future, the cost of your debt will rise as well. As of right now, interest rates are at an all-time low, but this trend will most likely reverse in the near future as the Federal Reserve is looking to raise interest rates which will force the overall cost of borrowing to increase for consumers.
Don’t Forget To Save Money Along the Way
Paying off your credit card balance or your student loans is great, but if you are cutting debt at the expense of your retirement portfolio, you will end up disappointed in the future. A lot of employers are offering 401(k)s and they are willing to match a certain percentage of your salary if you are committed to contribute into your 401(k). In a sense, this is free money that you should not pass on.
Available Debt Help
If you have been struggling to pay your bills on time for a long period of time, there is help available. The first step would be to talk to your creditors and try to work out a modified payment plan that can possibly trim down your payments to a more controllable level. The second step would be to contact a debt relief company, like a credit counseling agency. HCCI is such an agency that can help you get a debt management plan together that works for you. They can also advise you on other options. The other debt relief options include debt consolidation, debt settlement, and bankruptcy. These options have advantages and disadvantages so make sure to proceed very carefully.
Be on the lookout next week for more helpful tips about personal financial management during Financial Literacy Month. If you have any questions about debt management or other financially related questions, Powercat Financial Counseling is here to help. You can make an appointment at our website: www.k-state.edu/pfc. We provide free and confidential counseling to all K-State students.
Powercat Financial Counseling