Do a Financial Cleanse
Forget your weight-loss resolution. Trade your juice cleanse for a debt detox. Those financial burdens don’t just weigh us down mentally — they also put future goals (like owning a home and enjoying a swanky retirement) at risk.
We asked financial experts for their best advice on paying down debt. Here’s how to cleanse yourself of financial toxins in 2015.
Face the Facts
Expose those debts, warts and all. Unearth every bill, statement, and balance you have. This way you can prioritize which ones are the costliest and need to be paid off first. Take an inventory of everything: balances, minimum monthly payments, interest rates, and fees.
“Mathematically speaking, it makes the most sense to make minimum monthly payments on all your debts, then designate whatever money remains toward the debt with the highest interest rate so you can pay off that debt first,” says Stefanie O’Connell, a personal finance expert and founder of The Broke and Beautiful Life.
After paying off debts with high interest rates, tackle those with the tightest rules. “Give priority to debts with less leniency,” says O’Connell. “For example, if you fail to pay your tax bill, the IRS can hit you with a federal tax lien as well as garnish your wages, bank accounts, Social Security benefits, and retirement income — not to mention you could wind up in jail!”
Does the KIND of Debt Matter?
In a word, yes. Credit cards are nastier than student loan debt, for example. “Student loans are a different kind of debt than credit cards. It’s more important to get rid of balances on credit cards because you have less control over interest rates and monthly payment amounts,” explains Lauren E. Hardy, owner of Bespoke Wealth Management.
Student loan interest rates are also often lower than bank balances and student loan issuers may be more forgiving than credit card issuers. “When you keep debt in the form of a student loan instead of a credit card, you’ll have more options in the future if you get into trouble (like if you make a job change and things get tight financially for a bit),” adds Hardy.
“You can call the student loan provider and ask them to forgive or lower your monthly payments based on your current income. And it’s important to focus on containing your debt into the vehicles that give you the most options and flexibility for paying them off.”
Consolidate Where You Can
When we’re talking high-interest debts, chances are it’s credit cards. “When possible, combine credit card balances onto your lowest-interest-rate card. You’ll have the same amount of debt, but you’ll have fewer payments to make each month, cutting back on the amount of hard-earned cash going to a bank in the form of interest charges,” says Hardy. “You’ll also be less likely to skip a payment by mistake.”
Then focus on paying off that credit card first, even if that means you can afford only to pay the minimum monthly payment on other large debts, like a mortgage, says Hardy. “It’s how corporations use debt to their advantage, and you can consider yourself a little corporation. It’s called leverage.” (Hey, if corporations can be people, then we can be corporations.)
By freeing up that extra income you’ve been putting toward paying down your mortgage and repurposing it to pay off that consolidated credit card, you’re actually using your mortgage as leverage to strengthen your bottom line. Want to free up even more money? Consider refinancing your mortgage, too, since mortgage rates are extremely low right now.
“Anything below 6 percent is a good rate historically speaking, so if you can get your rate locked in now, it’s an excellent thing to have in your tool chest,” Hardy says. By lowering your monthly mortgage payment with a refi, you’ll pay off that credit card even sooner.
Talk to Your Lenders
It may seem counterintuitive to go straight to the source, but by calling your lenders and facing your debts head on, you open up the door for debt relief through negotiation, suggests O’Connell. “And if you can’t afford all your payments, it’s much better to review your various consolidation and repayment options than to simply default,” says O’Connell.
Got a debt already in collection? According to the Consumer Financial Protection Bureau (CFPB), a federal agency that protects consumer rights in the financial sector, you can request a repayment plan that fits your budget. Often a debt collector is more open to a deal than the original creditor because they’ve been hired specifically to collect on your account one way or another, says the CFPB.
Tighten Your Spending
You knew this one was coming. You can’t talk about a detox without eliminating what’s dragging you down. “I recommend using an ongoing tracking app that will let you know when you have exceeded one of your spending areas for the month, says Kathleen Longo, president and founder of Flourish Wealth Management. “This is a great tool to keep you in tune [with your] spending and change behavior.”
To pay down debt, you also need to understand how you accumulated the debt in the first place. “Many times, the debt is more about living beyond our means,” Longo says. “If you don’t change those spending habits, you will quickly be in the same place or not make the progress you were expecting.”
Reexamine That Paycheck
Where are you going to free up the money to pay off these debts? Start with your pay stub, says Longo. “Look at your withholding and make sure it is line with your annual tax liability. I see many people who allow too much withholding because they like the large refund at tax time,” she says. But when you’re paying off debt, keep your cash liquid. “It would be better to take this money each paycheck and use it toward retiring debt.”
You can also try to drum up new income sources (temporarily) to put toward those costliest debts. “Take a look around the home and see if there are any items you no longer want. Consider selling these items on Craigslist or Ebay to generate a little extra cash to use toward debt,” suggests Longo. Or take on some additional freelance gigs. Now that you’re not shopping on Saturday, you can spend that extra time earning.