It's just you against your mountain of debt, what's worse, you're likely in this mess because "Past You" betrayed you and threw you under the debt bus. Debt plagues the young and the old alike, causing sleepless nights and anxiety. Winning the battle with debt is key to getting your life back - we'll share a broad range of strategies, some of which might be right for your circumstances.
The average American household owes close to $17,000 on credit cards, on top of that, for some, is student debt. The average student graduating college in 2016 owes $37,000 in student loans. Everyone's situation is different and your unique savings, income, and expenses will make a difference whether what you owe needs to be repaid promptly and how much you can put towards paying off your debts today. You have to consider that it's likely that interest rates will go up in the future, so that putting off repayment may make it even more expensive later. So let's assume you want to take down that debt as soon as you can and you are going to work with all the FiClub tools available: a coaching session, getting insight on your expenses, and considering ways to improve your income. Here is the general recipe that your FiClub Coach is likely to walk you through, advising you to select what is most suited to your needs and makes the most sense for your life.
1). Automate minimum payments
2). Review credit score - consider whether credit repair needed, check if some accounts are more of a drag on your score (consider paying those off faster and closing them)
3). Balance transfer - use low/zero interest offers, consider refinancing with peer-to-peer loan
4). Accelerated pay-down plan - high interest rate first vs. snowball method vs. high utilization
5). Negotiations and settlements - if debt is unmanageable, consider working with creditors to adjust your balance or terms. Note: this strategy may affect your credit score for years and is not to be used recklessly.
6). Bankruptcy - for cases of extreme debt, where paying off your obligations is unlikely or not possible, the sooner you take action, the sooner you'll get through it.
1). Automate minimum payments:
The first step when we take control of our debt is to avoid missing payments at all cost. Make this foolproof by automating it. Most banks and credit unions offer online bill-pay and most credit card accounts allow you to set up automatic minimum payments online. This will avoid incurring late fees or further damaging your credit score, which as we cover in following sections, is what will help get you more wiggle room to make progress.
2). Review your credit score:
Lenders like banks, credit card issuers and mortgage lenders look at your credit score when deciding what terms you qualify for. The better your credit score, the more likely you are to get lower rate offers. It helps to know where you stand with your credit score, You are entitled to a free copy of your credit report from from each of the credit bureaus (Equifax, Transunion, Experian) each year. If you have not yet taken advantage of this, use this site: annualcreditreport.com, or call 1-877-322-8228. Review whether the information is correct and make sure to dispute any inaccurate negative items. There are agencies and services that offer assistance with credit repair, some perform a valuable service others are out to take advantage of people in a desperate situation - make sure that you are clear on what you are signing up for. This is one of the cases where it is worth checking reviews and references, reading the fine print and asking for a copy of any legal agreements.
A good free service to sign up for is Credit Karma that allows you to monitor your credit scores and also look closer at how your score is affected by your payment history and how close to your limits you are for each account (what they call "credit utilization", which is bad for your score when it's high). With Credit Karma's "credit simulator" tool you can run some "what-ifs", like how much would my score improve after I pay my balances down to zero:
Notice how the score for this person would have increased by 88 points, going from "Good" to "Excellent"? With an 800 credit score, that would mean that they could qualify for 0% interest offers and other perks as lenders compete to earn their business,
What would happen to my score if I have a 2-month late payment?
That's a huge drag on your credit score, and as they point out, it impacts you for at least 18 months.
3). Balance transfers:
If your credit score is good, you may from time to time get offers from your existing credit cards or from new ones that are trying to earn your business with balance transfer offers with a limited time low or zero interest rate. If you are carrying balances, the average interest is currently 14%, that means that a $10,000 balance it's going to cost you $1,400 each year. Being able to take advantage of a balance transfer to a 0% interest offer saves you $1,400 dollars. That means you'll be able to pay off your debt all the sooner if you get this break. I hope that makes clear the value of protecting that credit score or slowly repairing any past harm by maintaining a good payment record going forward. The danger with balance transfer offers is that they eventually expire (typically 12-18 months), and you have to be careful not to fall back on bad habits and ramp up your debt in addition to the new card or offer. Just because you got a new shovel, doesn't mean you dig a new hole.
Another way to restructure your debt is to get a fixed term loan from a peer-to-peer lending service. The most widely known are LendingClub and Prosper, who offer loans on which you'll have to make equal payments for 36 month or 60 months. The rates they charge are usually better than what the credit card charge as their normal rate. People may see an immediate improvement in their credit score when they take out a peer-to-peer loan and start making regular payments. Others report that their budgeting ability improves if they cut up or put away their credit cards after getting the loan so they only have to deal with making a single monthly payment. Unfortunately, not everyone qualifies for peer-to-peer loans because these lenders tend to screen out borrowers with low credit scores.
4). Accelerated pay-down plan:
Now that we know where you stand with your balances, your minimum payments and having locked in the best interest rates available to you, it's time to create you pay-down plan. You would consider your overall financial picture to understand what amount per month you commit to paying, in addition to your minimum payments. There is a debate raging on the financial blogs about which method to use and your approach can be a blend of them. Mostly the debate comes down to what makes sense psychologically (which leans towards Method A - "the Snowball Method") versus what makes sense financially ( Method B - paying off highest interest rate debts first). I'll make the case for another method, and I intend also to show that with FiClub you can work on your psychology to clear the path for you to do what makes the most sense financially.
Method A - the Snowball Method:
People who follow the advice of a popular financial guru, Dave Ramsey use what they call the "Snowball Method" where you make minimum payments then pay-off the smallest debt first. The theory behind this is that you line up all your debts and treat each account as it it were an item on a to-do list. The smallest debt, you would be able to pay-off soonest by throwing all your extra cash at it. Then you cross it off and feel the glow of a sense of accomplishment, which encourages you to stick to your method for the months to come, based on showing you some early wins. It manages the psychology of the debtor and gets that on track.
Method B - Highest Interest Rate First or "Avalanche" Method:
Other people are more focused on the dollars and cents of it, and for them "Snowball" doesn't make sense because it costs more in cents and percents. If you have 4 debts with different interest rates adding up to $20,000 ranging from 8% to 20% in interest, you're better off taking each dollar you have beyond what's needed for minimum payments and throwing it at the debt that is costing you 20% or more than twice as much month after month in interest. You'll save more money next month to be able to pay down your debt faster. It's just math and the lower your average interest rate, the better off you are.
I've thought about it and in weighing the two approaches, it seems like the first assumes you are weak and need some little victories and gold stars to goad you towards your goals, the second treats you like a grown-up and gives you the path with the least steps to victory.
There's an easy calculator you can use to do the comparison at unbury.us
I ran the test with $20,000 for someone who can afford to pay $500 per month total toward their debt - let's say your debts look like this:
Here's what paying it off with the Snowball method looks like:
And here comes the Avalanche:
In the first case, you pay a total of $10,685 in interest over the life of your debts, in the second you pay $6,432.
I'd say the FiClub recommendation is that we admit our weakness but not coddle it. Each month, the Snowball Method is costing you hard cash in interest dollars you are handing over to the banks for the privilege of thinking of your accounts as separate items with check-boxes on a To-Do list. Re-frame it in your head, add them up and call them "Debt", not different accounts. Get out a piece of paper and do this if you have to:
Each extra payment that you make towards your highest interest debt, you can write "not your chump" in the Notes section and take pride in that little victory.
One small twist in the path: you can improve your credit score by lowering the utilization percentage on your cards. Any card that is above 60% utilization may be hurting your score and would need to be paid down first. Your overall utilization % has a bigger impact than any one account, so "snowball" or any other method works the same - the more you pay down, the better. Beware of the advice of closing your accounts, though - that will hurt your utilization % to delete a fully paid-off account from your available credit. You are better off cutting the cards up if you need to in order to avoid spending but keeping the fully paid accounts open in your credit file - that 0% utilization and available credit helps your totals. If any of this is confusing, talk to a FiClub coach or ask questions through the blog comments or by email.
5). Negotiations and Settlements:
It's the military equivalent of retreat - you aren't really winning the battle with debt with this option and it will likely leave some scars on your credit report. Sometimes you have to do what you have to do but do not take this route lightly without having weighed the options and exhausted all other possibilities: have you gotten a handle on your impulse spending and other money leaks that can be plugged? Have you considered ways of boosting your paycheck and even getting a second source of income? Have you looked into balance transfers and peer-to-peer loans like we discussed above? Do you have valuables to sell or savings you can draw from to make your payments? Can you cancel recurring bills you committed to in the past like a subscription or a timeshare? Kick tobacco addiction and put that $5-a-pack habit towards being debt free before you smoke your credit.
Bankruptcy is the equivalent of surrender, throwing in the towel, raising the white flag. If you are forced by circumstances beyond your control to have to walk away from your debts and obligations, make sure that you have good legal help. Research your options thoroughly and select a lawyer with a good reputation you can verify independently. Know that rebuilding your life and credit after a bankruptcy will require ongoing work. FiClub can help you turn those painful experiences into lessons learned so you are able to draw strength and wisdom to move forward with your life.
What it Takes to Win the Battle with Debt:
The heart of a fighter, the head of a general.
Someone in your corner to cheer you on - FiClub.