One of the biggest obstacles to financial wellness and a secure retirement is debt due to mortgages, credit cards, car payments and student loans. According to a 2021 CNBC Report the average American has $90,460 in debt including their mortgages. Having any debt takes money out of your disposable income and future retirement savings.
It’s important to pay off debt because debt most likely involves paying interest, the cost of borrowing the money. The average interest rate for a new credit card according to Bankrate.com is 16.6%. If you have $5,000 in credit card debt at 16.6% and you pay the minimum payment of $200 every month, it will take you 10 years and 8 months to pay off this debt and you will have paid an extra $2,533.36 in interest payments. By paying off this debt, you have the more expendable income to put toward an emergency fund, save or invest. Also, paying off debt may improve your credit score.
Paying off debt can be done by first making a plan and sticking to it! As Benjamin Franklin said, “By failing to prepare, you are prepared to fail.” The plan needs to be realistic, written down, and measurable. For example, don’t set up payments toward the debt that aren’t realistic. Set up your plan for success by budgeting an amount more than the required minimum payment from each paycheck or each month’s budget. If you don’t have a budget written out, start there. When making payments above the minimum requirements, observe how the debt is being reduced and be proud of your success. Paying the minimum payment each month on your credit card costs you more money and that adds up.
If you have money in a savings account or other sources of accessible cash, use those funds to pay down the debt. Your savings account may be currently earning less than 1% interest and the average credit card interest rate is much higher. If you have $5,000 in a savings account and don’t add any contributions, with an average APY (annual percentage yield) of .10% over 10 years and 8 months, the account would only earn $53.59 interest. If you have $5,000 on a credit card with a 16.6% interest rate and pay the minimum, over the same time span you will be charged $2,533.36 in interest. Use funds in low interest-bearing accounts to work for you and pay off the high-interest debt first.
Other ways to reduce debt are to consider selling items you no longer use for cash or use your tax refunds to pay down debt. You can also ask for a raise from your employer, or do a credit card balance transfer but read the fine print and understand what you are signing. Also, try calling your credit card company or lender and attempt to negotiate a lower interest rate. When debt is a burden, you may want to consult with a credit counseling agency. These agencies help consumers create a personalized plan to pay down debt and develop a solid financial plan. Make sure the credit counseling agency is a non-profit organization and has a good reputation with education resources. Scammers in this area are abundant.
Once you have paid off your debt, guard against incurring more debt again. Setting up an emergency fund is essential so car repairs and other unexpected expenses are paid for without additional debt. Don’t exceed your disposable income with credit cards or loans, and always pay your bills on time and in full each month.