Got debt? If you're like many Americans, the answer is probably yes. In fact, a recent study found that, as of December 31, 2018, total household debt in the US added up to approximately $13.54 trillion.
With so many people in debt, we decided to talk to an expert. We reached out to Marc Henderson, a CFP® and Financial Advisor, to get his best tips for getting out of debt. Here's what he had to say.
How would you define personal debt and what are the most common reasons that someone gets into debt?
Marc Henderson: Personal debt, also known as consumer debt, is money owed by an individual to someone, typically an entity like a bank. Most Americans acquire debt as a result of purchasing goods and/or services that they want or need, but don’t have enough money to buy.
There are many forms of personal debt and they are commonly categorized in these five areas: mortgages, student loans, credit cards, auto loans, and personal debt. The other thing to consider is if the debt is secured vs. unsecured. Secured debt is backed by some form of collateral. In the event you as the borrower are unable to pay your debt, you are contractually obligated to return the collateral to the lender. An example would be your home. If you are unable to pay your mortgage, you risk losing your house. With unsecured debt, like a credit card, there is no collateral, and you risk paying more in fees and interest.
Are there any misconceptions about personal debt?
MH: One of the misconceptions about personal debt is that one should avoid it. I believe personal debt is amoral, meaning it is neither good or bad, but many of us fail to leverage it to our advantage. One way to leverage debt to your advantage is to use it to acquire assets that appreciate in value, like the purchase of real estate. The goal is to be wise with debt and to leverage it in such a way that it increases your net worth.
What is the first thing that someone hoping to lower their personal debt should do?
MH: The first step in lowering your personal debt is taking a snapshot of where you are today. I suggest the old school method of using pen and paper. List all of your debts to get an account of where you are. I also suggest getting an updated credit report to ensure there are no other outstanding debts that you may have forgotten. Federal law allows you to get up to three free credit reports every 12 months by going to annualcreditreport.com.
What other tips do you have for someone trying to lower their personal debt?
MH: I recommend a four-step approach.
Step 1: Organize. Take time to list and answer the following questions: Who do I owe? How much do I owe? And what is it costing me (i.e., what is the interest rate?)?
Step 2: Prioritize. Once everything is listed, the next step is to create a plan to pay off the debt that is costing you most. List your debts beginning with the highest interest rate first descending to the lowest. During this process you want to also identify the minimum monthly payment required for each account. Lastly, you need to determine how much above the minimum payments you can afford on a monthly basis. We’ll call this monthly amount the “debt eliminator.” (We'll come back to that in Step 4!)
Step 3: Analyze. Now that you have everything listed, you are able to determine if there are opportunities or alternatives to paying off the higher interest rate accounts. For example, I have a client that had about $27,000 in consumer debt that included credit cards, student loans, and a few personal loans. He has a decent credit score and a long banking relationship with a local credit union. After realizing that his interest rate on his credit card was 28.99%, we decided to apply and transfer the balance to a personal loan offered at the credit union which now was going to reduce his interest rate to 9.99%. We did this process with each account and was able get $15,000 of his debt restructured in a better loan.
Step 4: Implement. The next step is to apply a debt payoff strategy known as the debt snowball method. You can do an internet search for "debt snowball" and find lots of articles and calculators, but here’s a brief overview: First, pay the minimum on all your debts except for the one with the highest interest rate. Second, take your “debt eliminator” mentioned above in Step 2 and apply that to the minimum payment of the highest interest debt. Then, once that debt is paid off, apply the amount allotted to the last “debt eliminator” to the next account. Every time a debt is paid off, add the sum of the previous allocations to the new “debt eliminator,” hence the snowball effect, until you are debt free. I recommend automating this process as much as possible.
Is there any other advice you’d like to add?
MH: Professional financial advice can pay for itself when it comes to creating a plan to pay off personal debt. The rules can be complex and a wrong or emotional decision can be costly. If you are a do-it-yourselfer, be sure to have a plan and consider sharing your financial goals with a friend, partner or your spouse. Having someone that you are accountable to increases your chance of success.
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Marc Henderson, CFP®, a Certified Financial Planner™, runs a Los Angeles-based financial planning practice whose mission is to educate and empower clients to make wise financial decisions so that money can be used as tool to turn their goals into reality. He is passionate about personal finance and believes in making the complex simple. Marc has been working in the financial industry for over 10 years and holds a Bachelor’s Degree in Communication Studies from California State University, Northridge and a Personal Financial Planning Executive Certificate from Pepperdine University.