In a recent poll conducted by NBC showed that 75% of millennials in the US are in some form of debt. A quarter of millennials — those 18 to 34 years old — are over $30,000 in debt, including 11 percent who are over $100,000 in debt. Only 22 percent of millennials are debt free. This has caused many to hold off some of the key milestones in their life.
There was time in my life, as well, when I had approximately $36k in revolving debt and these did not include my mortgage, car payments and others. Over a period of 4-5 years, I was able to turn around my financial situation to just the house mortgage debt and approximately $125k savings in the bank. How did I do it?
Before I get into the details of my debt management steps, we need to understand the basic two types of loans and how they impact your credit score.
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As the name suggests, loans with a collateral are called secured loans. It is comparatively easier to obtain as you are providing a lien in case you default. Some of the examples of secured loans are mortgage, car loans, etc. In these cases you are taking a loan against a property of yours and in the event you default the bank or financial institution will take possession of your asset. Having a secured loan with regular payments could have a positive impact on your credit score.
Unsecured loans are just the opposite where you are given a loan without any collateral. These include credit cards, personal loans, personal line of credit, student loans, etc. In this case, the financial institution solely rely on your financial history and credit score. They are harder to get especially if you are just starting out or have a bad credit score. Having large balances in these accounts could have a major impact on your credit score.
Debt payoff strategy
Now that you know the two basic types of loans/debts. Your focus should start with getting rid of all if not most of your unsecured debt. In this post, I am primarily going to focus on paying off your unsecured debt using some simple strategies such as creating a plan and reducing the interest payments.
Before you start on a plan, the first step is to create your baseline. One needs to understand what is coming in and what is going out on a monthly or bi-weekly basis. This would mean your income (coming in) and your bills (going out). For this, I used a simple app called Mint where I aggregated all my accounts.
A plan is only good as long as it is practical and you have the discipline to enforce it. Avoid lofty goals in the beginning as they will make the goal difficult to achieve and you will lose interest.
Using the information from Mint I created an excel sheet with balances of all my revolving accounts. I started filling in the dollar amount I could afford each month until they had zero balance. This was the point that was becoming hard for me as I could not easily calculate the accrued interests on the balances.
I explored ideas to make it manageable and here are few of them that I implemented.
Credit Card Consolidation:
Now comes the interesting part. I had one credit card which was offering me a zero percent balance transfer for up to one year. Fortunately I had a low balance on the card. I paid off the balance and moved the balances from other cards to it for a 5% transfer fee. The transfer fee although high, was far less than the 15-30% interest I was paying on the other cards every month. This allowed me to have a fixed balance (up to one year) and I was able to chew off bit by bit from the balance.
If I did not have a card with the balance transfer option, I would have applied for a new card with an introductory balance transfer offer.
As mentioned previously, I also had a balance on my personal line of credit at 9% APR. An LoC is considered the same as a credit card so I had do something about it to make it manageable. I had received an offer via mail from my bank for a pre-qualified personal loan at 6%, which I decided to apply. Apart from the lower interest rate, the major advantage was the fixed amount that I had to pay. There was no ambiguity on the interest increase per month as all of it was done by the bank to a fixed monthly payment. Personal loans are treated slightly different from credit cards as they are not revolving credit causing minimal impact on your credit score.
HELOC or Home Equity Line of Credit was another option that I looked at however I ended up not using it. It is a great option if you have some equity built (around 20% of home value). The interest will depend on the current mortgage rates but they are usually lower than credit card interest rates and much easier to obtain as you are providing your home as a collateral. There is a risk of you losing your home if you default on payments but the point of this post is to have the required discipline to never get into such a situation.
This is a mixed bag. One of the key factors to reducing debt and increasing your net worth is increasing your income and reducing spend. Increasing income may not be as easy as it sounds, but I started a consulting gig on the side (check my post here) and my wife started moonlighting. There are many ways to increase to income by working overtime, if you have option, or starting a side gig. A simple search on the web will give you tons of ideas.
We also analyzed our spend and eliminated all those unnecessary subscriptions. Implemented few changes in our house to save of energy costs which I have detailed in a separate post here. My wife created a grocery plan which we stick to and in the process reduce our grocery bills (details here).
The key to eliminating debt starts with taking control of your finances. Even after achieving our first $100k in savings, my wife and I are constantly monitoring our spend. We have a budget that we stick to although in some cases we exceed it. Obviously there is a valid reason for it.
We started using a 30 day evaluation period on all our purchases. After 30 days if we still think we need the item do we purchase it. We taught our kids the value of deciding what we need vs what we want.