If you’re overwhelmed with debt, you are not alone. The average American family has $123,400 in debt, according to the Federal Reserve’s latest Survey of Consumer Finances.
The lion share of consumer debt is made up of mortgage loans (68%). However, student loans (10%), auto loans (9%), and credit cards (6%) still amount o an average of $12,250 per person.
This is not ok. Just because debt is common, doesn’t make it acceptable. Everybody’s number one financial goal should be to get out debt.
Our goal is that you become debt-free as fast as possible. The following steps and tools will help you get there.
Step 1: Take time to get a handle on your financial situation
For many, this is the hardest step in our guide. After all, who has time to sit down and create a budget. Unfortunately, there is no way around it. To start, create a simple spreadsheet with a row for each creditor. Include auto loans, student loans, mortgages, credit cards, and any other source of debt. Include the balance you owe, the interest rate you’re charged, and the monthly payment. If it’s a credit card, include the minimum payment. In the last column, specify whether the debt is secured or unsecured. To illustrate, a mortgage is a secured debt because the bank will take your home if you don’t make payments. Credit card debt, on the other hand, is unsecured debt.
The list may look something like this:
If you’re not sure about the balances in all your accounts, check your credit report. It will have a list of all the creditors that report to the credit reporting bureaus. The balances on your credit report may not be 100% accurate. Once you have a list of creditors, confirm the balances with them. Now you know the extent of your debt and the money you have available to pay it off, you have some serious decisions to make.
Step 2: Reduce and simplify your interest expenses
Consolidate unsecured debt
Debt consolidation allows qualified consumers to take out a new loan that pays off most or all their outstanding debt. The purpose of debt consolidation is to combine all your existing debt from various sources into one loan.
This means that you only have to pay one loan payment a month instead of several smaller loan payments. Ideally, debt consolidation loans should have a lower interest rate than the rates you are currently paying
What options are available for debt consolidation?
It boils down to three main options. You can:
- Get a personal loan.
- Transfer all your other credit card balances to one card.
- Apply for a home equity loan or cash out mortgage refinance.
If your credit isn’t where it needs to be to get approved for a balance transfer card, consider applying for a personal loan. You won’t get any 0% APR offers and the interest rate can be higher than that of a HELOC. But this alternative’s unsecured nature means you’re not risking any collateral.
A couple of things to keep in mind with personal loans:
- A lower interest rate isn’t guaranteed. Depending on your credit, you may not get approved for a loan. And if you do, the APR may even be higher than your credit card’s APR.
- Personal loans have a fixed repayment period and fixed monthly payments. Make sure you can afford the payments before accepting a loan.
Consolidating your debt can improve your credit score
Personal loans can also help improve your credit score. How? Well, 10% of your FICO credit score, the score most widely used by lenders, is based on your credit mix. Having a varied credit mix, such as personal loans, mortgage, and credit card accounts can improve your credit score. Your credit utilization ratio on revolving accounts — your debt as a percentage of your available credit — is also an important factor when calculating your FICO scores. Moving revolving credit debt to a personal loan will lower your credit utilization ratio, which could improve your credit.
Purchasing a loan is like buying a used car. Prices vary wildly depending on whether you buy from a private owner or a dealership, as well as on the age, brand, and condition of the vehicle. Personal loans are also a highly competitive business where prices vary by provider. So get ready to kick some tires.
SuperMoney’s loan offer engine makes it easy to compare your options across many different lending partners without affecting your credit score. You can also research product details and company reviews directly on SuperMoney’s personal loan review pages.
Balance transfer credit cards
Consider switching your credit card debt to a 0% APR balance transfer card. If you have $15,000 in debt and an average 15% APR, you could save $1,940 in interest during just 12 months of 0% APR. Combine a 0% APR balance transfer with an aggressive repayment plan, and you could repay your entire credit card debt in less than a year.
Remember balance transfers are not always free. The APR may be 0%, but APRs don’t include balance transfer fees, which can be as high as 5%. There are balance transfer credit cards, such as Slate, that don’t charge transfer fees, but these are rare. This doesn’t mean you shouldn’t transfer your credit balance. Make sure you take into account these fees when calculating the pros and cons of a balance transfer.
Home equity loans
A home equity line of credit is similar to a credit card in that you have a revolving line of credit that you can use, pay off, and use again. The difference is that most credit cards don’t require collateral, while a HELOC uses your home as collateral.
Because of this setup, HELOCs are considered secured debt and have relatively low – and usually variable – interest rates. To illustrate, the average APR for credit cards in 2018 was around 16%. The average APR for a HELOC was about 5%.
The obvious advantage of using a HELOC to pay off credit card debt is that you can consolidate at a lower interest rate, even if you have poor credit. Another reason why a HELOC is appealing is that, like your mortgage payments, the interest you pay is tax deductible.
However, there are serious drawbacks to consider. The worst that can happen if you don’t pay your credit is a damaged credit score. If you don’t make payments on your HELOC, you could lose your home.
Refinance secured loans
Refinancing your loans for shorter terms and lower interest rates can save you thousands of dollars and help you pay off your debt faster.
Mortgage debt represents 68% of American households’ debt. Imagine how much you could save if you lowered your housing expenses by refinancing your mortgage. To illustrate, a 1% interest reduction on a 30-year $300k mortgage could lower your monthly payments by $178 and reduce the total cost of the mortgage by $64,000.
If you qualify for a mortgage refinance, consider a cash-out refinance to consolidate and pay off your other debts.
A cash-out refinance involves getting a new loan with a slightly lower interest rate for a larger amount than the existing mortgage loan. As the borrower, you receive the difference between the two loans in cash to use as you please. In this case, you’ll be using the cash to pay off your high-interest debt like credit cards, a car loan, or a personal loan.
For instance, say you own a home valued at $250,000 and still owe $150,000 on the mortgage. You’ll have built up $100,000 in equity. You need an extra $25,000 to pay off some credit card debt and a car loan.
You can get a cash-out mortgage refinance with a new loan for $175,000 ($150,000 loan you’ll still owe on your home via mortgage payments, plus $25,000 cash). With this strategy, you can consolidate debt into a home loan and pay it off at a much lower interest rate.
Compare rates and terms from top mortgage refinance lenders now.
Student loan refinancing
The average debt of a four-year college student is $26,830, according to the Federal Student Aid Office. For some graduates, that could amount to more than half of their starting salary.
If you’re looking for ways to relieve the burden of your student debt, considering refinancing your student loans. You may qualify for lower interest rates if your student loans are older or if your credit has improved.
Compare the top student loan refinancing lenders to see which one offers the best feature combination for your needs.
Auto loan refinancing
If you decide to refinance your car loan, it can save you money and possibly reduce the length of the loan. SuperMoney’s auto loan offer engine makes it easy to compare the rates and terms of the top auto refinance lenders.
Say you owe $20,000 on your auto loan at 7% interest, and you’re paying $300 per month for the next 85 months, you’ll pay $5,401 of interest over the life of the loan. Here are interest reduction scenarios for comparison. (Keep in mind–these loan refinancing scenarios are examples and don’t include any taxes or extra fees.)
- A reduction to 5% interest will lower the monthly payment to $280, saving you a total of $1,702.
- A reduction to 4% interest will lower the monthly payment to $271, saving you a total of $2,490.
- A reduction to 3% interest will lower the monthly payment to $261, saving you a total of $3,262.
Step 3: Make more money
Increasing your monthly income will allow you to put more towards repaying your debt.
Get a side job
If you’re trying to climb out of debt and have cut as many expenses as possible, it may be time to supplement your income. Thanks to today’s gig economy, it’s easier than ever to find “moonlighting” jobs that allow you to quickly increase your income.
If you want to earn some extra money pronto, consider one or more of the following side jobs.
Admit it. You have way too much junk. The average household has $1,000 to $2,000 of potential cash in stuff they no longer use. Empty that basement. Reclaim your garage. Get rid of that storage unit.
Step 4: Desperate measures
But what if your financial situation is so bad no amount of budgeting, consolidating, refinancing, or extra gigs will make a dent on your debt? In most cases, the tools mentioned above are enough to get a determined person out of debt. However, there isn’t always a way to dig yourself out of debt without help. In such cases, there are two tools to consider: debt settlement and bankruptcy.
How does debt settlement work?
A debt settlement is an agreement between borrowers and lenders to make a lump-sum payment instead of the full amount owed. It is one of the most aggressive and effective debt resolution methods available. However, it is not a debt relief method you should take on lightly. Debt settlement will probably damage your credit score and force you to deal with debt collection agencies. It is a last-ditch resort that forces lenders to decide between forgiving a chunk of your debt or getting nothing at all.
Why would lenders consider forgiving part your debt?
The threat of bankruptcy is what brings many creditors to the table. Lenders know that personal bankruptcy can discharge unsecured debt and prefer to get something than to be left standing with worthless promissory notes. If you can convince your lenders you cannot afford to pay your debt in full, they may agree to a discounted payment instead. How much of a discount are lenders willing to give? It all depends on your negotiating skills and your financial situation. You should also be aware some of your creditors may refuse to work with the debt settlement company that you choose.
When should you consider a debt settlement?
There are no hard rules about when you can purse debt settlement, but this is a useful guideline.
- Go to the list debts you created before. Add up all the unsecured loans.
- Pick up your cash flow budget and calculate how much disposable income you have after paying for bare necessities.
- Multiply your monthly disposable income by 60 (5 years).
- Divide the total by the total balance of your unsecured debt.
- Multiply the result by 100.
If the result is greater than 25%, you should probably not consider a debt settlement. If it’s lower, get a free consultation with a debt settlement expert and check your options.
This guide will help you decide whether debt settlement is a smart option for you.
How does bankruptcy work?
Bankruptcy is a legal process by which individuals and businesses can eliminate or repay debts under the protection of the federal bankruptcy court. There are two types of bankruptcies: liquidation and reorganization.
Chapter 7 is the classic liquidation bankruptcy. As its name implies, it requires debtors to liquidate or sell their property to pay some of their debt. However, some types of property are protected by state and federal bankruptcy laws. In certain cases, debtors may have little to pay once state exceptions (i.e. protected property) are applied.
Chapter 13 is the most common reorganization bankruptcy. With this type of bankruptcy, debtors get to keep all, or most, of their property. However, unsecured debt is not always discharged. Instead, it is reorganized into affordable payments. If a debtor completes the repayment plan (three to five years of monthly payments), pending unsecured debt is discharged. The catch is unsecured debt is generally not discharged until debtors complete the three to five years repayment plan. However, the completion rates of Chapter 13 bankruptcies are extremely low. Only a third of debtors complete the repayment plan.
This guide teaches you everything you need to know before you decide on filing for bankruptcy.
Getting out of debt is only the beginning. Once you’re free of debt, it’s time to invest in your future. If you’re like most people, the final goal is to be financially independent and retire early.
Read our investment guide and start working toward financial independence today.