The purpose of Money Talk is to improve readers' financial capability with research-based personal finance information.
Friday, May 18, 2018
How to Dig Out From Under a Pile of Debt
The term “consumer debt”
describes money owed to others, excluding a home mortgage. It includes credit
cards, car loans, student loans, lines of credit, and other debts. There are
two types of consumer credit: revolving credit (where a balance can be carried
forward month to month) and installment credit (fixed monthly payments for a
High consumer debt is a problem
for many U.S. families and there is no easy way out. Rather, there are small
steps that can make the situation better over time. It is impossible to borrow
your way out of debt because new debt will just make things worse. The
solution, instead, is taking positive action. Below are five specific action
a Low Consumer Debt-to-Income Ratio- Monthly consumer debt payments should
not exceed 20% of take-home (net) pay, which is consider a “danger zone.” A debt
ratio of 10% to 15% is even better, especially for people living in high-cost
states and/or those with high ongoing expenses such as child care.
Less Expensive Car- When people spend less on a car, say $17,000 instead of
$26,000, they can take out shorter loans, make lower monthly payments, and/or
be underwater (i.e., owing more than your car is worth) for less time.
Purchasing options include a smaller, lower-cost new car or a late model “new
used” car in good condition. Services that comparison shop and negotiate prices
on a buyer’s behalf may also be useful.
PowerPay Debt Acceleration Calculation- PowerPay
is a free Utah State University website that shows how much time and interest
can be saved by accelerating debt repayment. If people have multiple creditors,
PowerPay will create a calendar of monthly payments. As each debt gets repaid,
its payment gets applied to payments for remaining creditors. Debts can be
accelerated in order of highest interest rate, lowest balance, and shortest
Income for Debt Repayment- Sometimes, it may be possible to apply a large
lump sum toward reducing or eliminating debt. Sources of extra cash can include
working overtime, freelance work, reducing household expenses, expenses that
end (e.g., child care), completing a savings
challenge, and/or receiving a raise or bonus.
When Needed- Non-profit credit counseling agencies can assist people whose
consumer debt has gotten out of hand. They may be able to negotiate concessions
from creditors (e.g., waived late fees and lower interest) but will probably
require clients to surrender their credit cards to not run up additional debt.