Debt is a major issue for many Americans. Today, there is $866 billion of existing credit card debt in the United States, not to mention billions in home, car and school loans and more. No matter which type of debt you have, there are smart ways to handle it that can save you money and protect your credit rating. In this section, learn the basics about managing debt and living within your means.
Why manage your debt?
Of the many reasons why you should keep your debt under control, these are the most important:
Too much debt can be expensive! Whether your APR is .99 percent or 24.99 percent, you are paying more than you bargained for when you made the original purchase.
For example: If you put $5,000 in home decorations on your credit card at a rate of 18 percent, even if you make monthly payments of $100 – over the years, you will spend $4,400 in interest alone, not to mention the hidden fees credit card companies can charge.
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Protect your credit rating
With a poor credit rating, you may have trouble getting approved for home and car loans in the future. Even if you are able to get the loan you want, chances are you will have to pay higher interest rates.
Achieve your goals
You can put the money you save on interest toward reaching your life goals like saving for college and going on family vacations.
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How to manage your debt
Use these four steps to pay off your current debt, establish a good credit rating and learn to live within your means.
1. Know how credit works
When banks and credit card companies offer loans, many people think: “If the bank trusts me with this much money, I’m going to spend this much.” This is a misconception, and it can lead you deep into debt that is difficult to come out of. As you choose how much debt to take on, remember that the lender loans you money so it can charge you interest and make money. The bigger your loan and the longer you take to pay it off, the more interest it can charge you. Over time, you can lose a lot of money if you take out a larger loan than you can handle.
One of the most common types of debt, credit cards are easy to get and convenient to use. Generally, they only require a small minimum payment each month so you can pay them off as quickly or as slowly as you want. When used cautiously, credit cards can help you build a credit rating to qualify for mortgages and car loans.
Unfortunately, credit cards are often overused. The average American household carries more than $7,400 in credit card debt. With interest rates as high as 24.99 percent annually and minimum monthly payments as low as $15, it can take years and thousands of dollars in interest to pay off, and it can hinder your ability to qualify for other loans.
Mortgages, car loans, school loans
Mortgages, car loans and school loans are more difficult to qualify for and more structured than credit cards. The amount and frequency of payments is determined ahead of time by you and your lending company. Generally, you can prepay (save on interest by paying more than is due each month), but you have to pay at least a certain amount. The interest rates are usually lower, but the repercussions are more serious if you fail to make a payment on this type of loan.
2. Pay down existing debt
Save money in the long run by paying off your excess debt as efficiently as possible.
Pay on time
Avoid late fees and the possibility of defaulting on your loan by paying on time every month. One way to make sure you do this is to use automatic payroll deductions.
Pay more than the minimum
As often as possible, pay more than the minimum required amount on your loans. Every extra dollar will save you money in the long run.
For example: If you have $5,000 in credit card debt at 18 percent APR and you pay $100 per payment, it would take nearly eight years to pay off. By paying just $10 more per month, it would take less than six and a half years to pay off.
Even if you have a low interest rate on your loan, it’s a good idea to pay more than the minimum because no matter how low your rates are, paying your loans over 15 years instead of 10 will usually cost you more in the long run.
(Be sure to know the terms of your loan before you prepay. Some lenders charge fees because they lose money when you don’t pay interest.)
Shop around for the best rates
Don’t settle for high interest rates, annual fees, late charges or balance transfer fees! Those costs add up.
Mortgage Loan Amount
Total Interest Paid Over 30-year Loan
If your lender won’t give you the rates you want or is charging you too many fees, shop around for a better deal. Remember: Lenders are competing against each other for your business, so you may find the rates you’re looking for.
Pay off the right debt first
Generally it’s best to pay off high-interest debt first. Usually credit card debt has the highest interest rate, but examine your situation to see for sure.
Minimize debt on depreciating assets such as computers, cars and furniture. These items lose value as time passes, and it may become a burden to make high payments on these items as their values go down.
In most cases, paying off debt is a top priority because interest rates on your debt will be higher than the return on your money invested elsewhere. However, if your savings rate is above your loan rate, you could benefit from making minimum payments and saving more money. This is usually the case with zero percent loans. However, for zero percent loans, remember to pay off the debt before interest starts being charged.
Protect your loved ones from your debt
If you die or become disabled, the burden of your debt will most likely pass to your loved ones. When you purchase life and disability insurance, make sure you purchase enough to cover your debts.
Take advantage of tax breaks
As you work to pay off your debts, take advantage of all tax breaks that are available to you, including tax deductions on interest for your mortgage and school loans.
3. Build a strong credit rating
If you establish a strong credit rating now, it will pay off in the long run when you apply for home and car loans.
Establish a credit record
To earn a strong credit rating, it’s important to establish at least one credit card, loan or bill in your name at some time. If you show lenders that you are responsible enough to systematically pay off a debt and make your payments on time, they will be more likely to give you loans in the future.
Pay off your first debt successfully
Your first loan is a key step in your long-term credit history. It will affect your ability to buy a house, start a business and gain credit for other future goals.
Pay on time
If you’re late in paying your bills or loans, it will reflect negatively on your credit report.
Cancel unnecessary credit cards
It can hurt your credit rating to have open credit card accounts that you don’t use regularly.
4. Live within your means
To avoid going into future debt, you must learn to spend only what you can afford. Before you spend money, evaluate it by asking: “Is this purchase going to help me reach my goals for the future?” If not, rethink the purchase.
When is it OK to use credit cards?
Try to use credit cards only when you have an emergency (plane ticket, car repairs, etc.) or when you know you can pay it off the first time you are billed (before being charged interest on the loan).
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