Understanding Debt: 8 Steps to Help You Take Back Financial Control

Debt happens and it’s not always easy to get yourself out of it. But taking back control of your finances is possible, even when there’s a mountain of debt preventing you from seeing the path to financial freedom. If your debt is spiraling out of control, here are a few steps you can take to help eliminate your debt.

Debt is money that you borrow with the understanding and agreement that you’ll repay the funds at a later date, along with any interest. It’s also important to remember that not all debt is bad. There’s good debt too such as making an investment on a house, education or obtaining a small business loan. 

Credit is a short term loan that allows you to buy now and pay back later, with installments usually paid monthly. If you don’t pay it back in full within a specific timeframe, you’ll be charged interest. If you do a good job managing your credit and maintain a good credit score, lenders will find you trustworthy and allow you to borrow the funds you need for a purchase.  

Debt is primarily categorized as either secured or unsecured. Secured debt means that there’s collateral or security on the loan that the lender can take if you don’t make the payments. An example of secured debt would be a home equity line of credit. Unsecured debt does not have any collateral and is solely approved by the borrower’s creditworthiness. The most common example of unsecured debt is credit card debt. 

Installment debt is sometimes referred to as a close-ended loan. The borrower receives a specific amount of money and given a period of time to repay, usually through monthly installments. Payments are usually the same every month with the borrower made aware of an end date. Some examples of installment debt would be a car loan, student loans and home loans. Revolving debt is sometimes referred to as an open-ended loan, which allows the borrower a line of credit with no end date and is permitted to spend up to their credit limit. 

● Paying bills late

● Only making minimum payments

● At or near limit on credit cards

● Don’t know how much you owe

● Use cash advances to pay other bills

● Denied credit or credit purchase

● Get call from collection agencies

● More of total income going towards debt

If you’re experiencing any of these, take steps immediately to get back on track. If you’re experiencing more than one of these warning signs, consider stopping by a Hughes branch to learn how we can help. 

Add up your total amount of debt and be sure to include the interest rates on those debts. Next, calculate your debt-to-income ratio (DTI). This is your total monthly payments divided by you after-taxes income (net income). Generally a debt to income ratio that’s less than 15% is considered good. If your DTI is around 15%-25%, you may want to use caution when spending. If it’s higher than 25%, you’ll need to seek help. A DTI with 35% or higher means you’re in a financial danger zone.

Stop using your credit cards and take a pause to stop creating new debt. Take a look at the amount of credit cards you have and assess which ones you can eliminate. Get rid of high-rate credit cards and consider keeping one or two that you’ve had the longest with the lowest rate.

Are you eating out more than you should? Shopping when stressed? It’s important to also learn how you got into debt. By recognizing what helped get you here, you’re most likely to take steps to avoid debt in the future.

Always start with a plan and establish a budget to help you stay on track of your spending and help you look for ways to cut expenses. If you’ve been receiving large tax refunds, consider adjusting your tax withholdings to help you keep more of your money when you need it. Finding a part-time job can also help alleviate some financial stress and help you put more towards your debt. Liquidate assets and look for things you can sell through a garage sale or Craigslist.

While not the best option, a loan from your 401(k) can help you get above water but be advised that there are some downsides to borrowing from your retirement fund.

● No application or credit check

● Can borrow up to 50% of invested amount or $50K whichever is less.

● If you repay on time, loan is shielded from taxes and penalties 

● Interest you pay on the loan is taxable

● Must repay within 30-60 days

● If you don’t pay within 60 days, 10% penalty, plus state and federal taxes if not age 59.5 (considered a premature withdrawal)

If you have a lot of credit card balances, you might be tempted to take out a debt consolidation loan. The strategy to consolidate is to use the loan to pay off any debt, then follow up by closing those accounts. It’s important to make sure the loan rate is lower than the debt you’re consolidating. 

● Multiple monthly payments become just one

Cons: 

● Your credit score could suffer

● Loan payments stretched over time and will likely incur a higher total cost to pay outstanding debt. 

● Can get back into debt if you continue to use credit cards

The two most common debt payoff methods are the Powerpay method and the snowball method. The Powerpay method involves paying off the highest interest rate debt while making minimum payments on the other debts. The Snowball method goes the other route, tackling the smallest debt first, then the next smallest and so on. If you’re one to need encouragement, the Snowball method affords you small wins giving you the momentum to keep going!

Can’t pay your bills? Call them before they call you. But before you do, know what you can pay and don’t agree to any plan you can’t afford. Talking to your creditor can sometimes mean you can settle for a lot less than you owe. Be sure to work out a payment plan that works for you

If discussions with creditors breakdown, ask for help from a credit union like Hughes. Credit unions can refer you to reputable counselors or agencies to intervene with creditors on your behalf. 

If you think you’ve fallen too deep into debt, bankruptcy is an option. But it’s advised to use bankruptcy only as a last resort as it comes with some negative financial consequences. Filing bankruptcy means it will be listed on your credit report for up to 10 years, making it visible to anyone granting you credit, and usually results in higher interest rates and much higher interest payments over time. Bankruptcy is a costly option but it is available to you to help you start fresh.