How To Get Out Of Debt
Contrary to popular belief, debt is not all bad. It can go a long way with helping you to meet personal goals. It can also help when trying to create a reputable credit score (check out last month’s article on the upcoming credit bureau). Unfortunately, the accumulation of debt along with poor debt management skills can bring out the ugly side of debt. Luckily, you have this article to help you manage and reduce your debt. Reducing your debt to a sustainable level is a major key to improving your finances. The following are eight tips to manage and reduce your debt:
Know Your Net Worth
Knowing your net worth is the first step to organizing your finances and building your wealth. Your net worth is the value of all of your assets (what you own i.e. savings, property, investments) minus the value of all of your liabilities (what you owe i.e. mortgages, personal loans, and other debts). If you owe more than you own, you have a negative net worth and if you own more than you owe you have a positive net worth.
Are Most Of Your Loans "Good Debt" or "Bad Debt"
Good debt: borrowing funds to generate long-term income and increase your net worth. Examples: real estate, business ownership, education. These loans typically carry a low interest rate.
Bad debt: borrowing funds to purchase items that quickly lose value and do not generate long-term income. Examples: credit cards, car loans, vacation loans, cash advances. These loans typically carry a high interest rate.
List Your Liabilities in Detail
Many people have multiple loans, but do not know the terms of the loans and how much time they have remaining on their loans. It helps to list your liabilities in detail, and if you cannot remember everything, contact your loan officer(s). When listing your liabilities, make a note of the terms of all your outstanding debt. Check out the example below:
Determine Your Debt-Service Ratio
Your debt service ratio is the portion of your income that goes towards servicing your debts. Lenders usually use this ratio when someone applies for a mortgage to determine if the borrower can manage the monthly payments. To calculate your debt-service ratio, add all of your monthly debt payments and divide them by your monthly gross income. This number should ideally be no more than 40%. If your number is higher than this, there is cause for concern. Do not panic though; we are here to help you make a plan to reduce your debt-service ratio so that you can have more financial freedom.
Create A Budget… AND Track It!
Simply put, a budget is an estimation of your income and expenditures over a specific time in the future. As you create your monthly budget, it is important to track what you actually spent and what you actually saved. This allows you to better understand your money habits and take control of your spending and saving. Forms of income include salary and investment income. Expenses include rent, car, utilities, insurance, debt payments, entertainment etc. Determine where you are overspending and make adjustments so that you can manage your debt payments.
Some budgeting tips that can help you get your debt under control:
Find ways to reduce your expenses such as downgrading your cable or phone package, using less electricity etc.
Cut back on spending on eating out or other forms of entertainment.
Plan for large trips or big purchases at the beginning of the year and make a plan to save for these large purchases. This will lower the likelihood that you will borrow for a large purchase or vacation.
Set Up A Payment Schedule to Repay your Debt Quickly
This can be done in many ways, but here are three suggestions:
Make an effort to pay off your high interest rate loans first.
Credit cards typically have the highest rates at 18 – 22%. Consumer loans also have high rates. Make a plan to pay these off as soon as possible by paying more than the payment required.
Make an effort to pay off smaller loans first, regardless of interest rates.
Perhaps the first method may not be easy for you to do right away. If you have smaller loans, it may easier to focus on those first and work your way up to the larger loans afterward.
You can try to consolidate your debt.
Debt consolidation is essentially taking out a new loan to repay a number of debts. This allows you to have a single loan, normally with more favorable terms (i.e.: one lower monthly payment, lower interest rate, less fees, etc.).
Tip: Do not spend more than you earn! Credit cards should not be used to purchase items you cannot afford or to pay other bills. When paying for items with a credit card, you should aim to pay off these items within the same month to avoid high interest charges. Where possible, use cash or debit cards for purchases rather than credit cards.
Make Extra Principle Payments Where Possible
Holding loans to maturity causes you to pay almost double or even triple the amount borrowed due to the interest. Talk to your loan officer about prepaying your loan (find out about penalties and fees). If your financial institution permits extra payments and you have some wiggle room in your budget, put extra funds towards your loan. A good strategy is to put a portion of your bonus or a portion of a salary increase towards principal repayments.
Build An Emergency Fund
Save three to six months’ worth of living expenses in the event you have a medical emergency or job loss. This will provide you with a safety net that you can use should an emergency arise rather than charging items to your credit card and accumulating more debt.
Do Not Be Afraid To Ask Assistance
If you find that you are having a hard time repaying your debt, speak to your loan officer about your challenges. Some financial institutions offer financial advisory services that can help you make a suitable plan to reduce your debt. Your loan officer may be able to assist with debt consolidations and other ways to help you become debt free.
Reducing your debt may seem like a daunting task. If you need further assistance, contact a financial planner who can help you to GET MONEY SMART! Paying off a loan is always a great feeling. Imagine all the things you could be doing with the money you’re using to pay your current debts. For example, you could save for retirement, save for a down payment on a home, or save for your children’s education. Having less money going towards debt means that there is more available to go towards the things that matter most.