If it seems like your debt is spiraling out of control, well… that’s because it is. Say you have a $2000 balance on a credit card which has an 18% annual rate. You make the minimum payment of 2%, or $40, each month. At this rate - if you continue to pay the minimum and do not accrue any late charges - it would take over 30 years to pay this card off. 30 years! These numbers really give you a clear view of how debt can snowball.
To get yourself out of this position:
1. Do Not Add to the Debt
Think about it like this: if you were in a boat with a hole in it, you can bail all you want, but you’re still sinking. You need to plug up the leak before you can make headway on the water inside. The same is true of debt. If you’re paying minimums and adding to your debt load, you are not making any progress. And worse, there is more and more water rushing into the boat, so to speak, and it’s coming faster than you can bail.
Stop adding to the debt. Do not put more on your credit cards and certainly do not apply for new ones. If you really have difficulty with this step, you can freeze your credit. When frozen, creditors cannot check your score/report, so they’re unlikely to extend credit. (This does not affect your credit score.)
2. Go Above the Minimum
As we saw from the example above, paying the minimum means that even small debts can take years to pay off. You’re essentially just paying on the interest, and the principal balance just sits there. The next month, you’ll have the balance plus 15-18% added on. When you pay more than the minimum, you chip away at the balance so you can gain a foothold against debt.
3. Have a Debt Repayment Strategy
What if you don’t have enough room in your budget to pay more than the minimum on every credit bill? It’s ok. Find a strategy that works for you - and stick with it. You could, for example, use the Debt Snowball Method. Here’s how it works:
- Target the smallest debt first, making more than the minimum each month. Say it’s a credit card debt on which you make a $75 payment. Bump it to $100 (or more if you can).
- Pay the minimum on each of your other debts.
- When you pay off that small debt, pay the minimum on the next smallest debt plus the $100 you were paying on the last one. Say it’s another credit card with a $100 a month payment. You will now put down $200.
- Continue this cycle.
Each time you pay off a debt, you will pay the minimum on the next debt plus whatever you were paying on the last one. In this way, it “snowballs” into larger and larger payments, allowing you to kill debt faster and faster. Many people like this method because you can see some wins pretty quickly.
4. Start and Add to Your Emergency Fund
The idea of saving six to 12 months’ worth of living expenses is overwhelming, especially when you’re struggling financially. The important thing is to start somewhere. Anywhere! Each paycheck, take out $100 - or $25 and add it to a savings account. Just make it consistent, and do not touch this money. And when you get a tax return or bonus, add it to the fund!
Yes, you want to focus on repaying debt, but this fund will help when you face an unexpected expense so you don’t dig that hole deeper.
5. Talk to Your Creditors
We know… this is the last thing you want to do when you’re in debt. Many people start avoiding phone calls from unfamiliar numbers because they do not want to confront the issue. Be proactive and call them! If you have been a consistent customer but have fallen on hard times recently, creditors may reduce your interest rate. Many credit card companies also have hardship programs. They don’t advertise them, but they may be able to help you get on top of your debt.
6. Decide If You Need to Take More Drastic Action
See if you can scrape up some more money: for example, can you take on a renter? Can you look for a roommate? Can you sell a pricy phone and downgrade to a cheaper model? What can you unload on eBay or Craigslist? Can you work some OT or find a weekend job?
But this may not be enough or it may not be feasible for you. If that’s the case, you may have to take more drastic action, such as:
- Withdrawing from your retirement fund. Do not do this unless you absolutely must. You will have to deal with early withdrawal penalties and tax liabilities (if you are not 59.5 years of age or older). And, of course, you will have less money working for you as you move towards retirement. Consider this option very carefully.
- Cashing out a life insurance policy. Again, this is not your first (or second or third!) option when it comes to paying debt. You will face tax consequences, and if you borrow from your policy, it may reduce the benefits for your survivors.
- Settling debt. Creditors may agree to take a one-time lump sum payment to resolve the debt. Usually, they do this when accounts are in default or at risk of defaulting.
- Credit counseling. A third-party service can negotiate with your creditors to create a debt management plan. You pay the credit counseling agency, and they will pay your creditors according to the terms of the plan. This can be risky, and not all credit counseling services are as honest, transparent, or ethical as they claim. Proceed with great caution.
7. Consider Bankruptcy
If your debt is overwhelming, bankruptcy may be an option. Filing for Chapter 7 can allow you to discharge eligible debts (non-eligible debts include student loans, child support, and certain tax debt); you must liquidate certain assets. Chapter 13 requires a repayment plan (usually 3-5 years), after which your eligible debts are discharged. There are implications for your credit score so be sure to discuss this option with an experienced bankruptcy lawyer.
Being in debt is frustrating, frightening, and stressful. But when you have a plan to climb out and to secure a better financial future, you can move ahead with more confidence. Take the first steps today; contact Robert Laney.