Control Your Reliance on Debt in 9 Ways
Debt is money borrowed by one party from another. As scary as it may seem, sometimes it’s necessary to make large purchases such as a home or college education. In some instances, you need good credit to gain access to affordable services. Once you better understand your relationship with debt, you can start to control and even use it to your advantage. Let’s take a look at what debt is, how it works, and why it’s needed.
Know your collateral options. Loans can come in a few different forms but all fall under one of two types. When a loan is attached to a piece of collateral, it is referred to as a “secured loan”. This collateral can be property or another asset that is pledged as security for the repayment of the loan. Examples of these are car loans and mortgages. If you have something of value you could use as collateral in an emergency, try to keep it in the best shape possible. This can give you more borrowing power later.
“Unsecured loans” can be personal loans, some lines of credit, credit cards, and other debts that do not require collateral. Usually these loans are higher interest as they carry more risk for the lender.
TIP: If you need a personal loan and have poor credit, ask your financial institution if you can use the money in your savings account as collateral for a secured loan. This can boost your credit and prevent you from dipping into your savings account for impulse purchases!
Balance your wants and needs by saving for a down payment!
If you are already using a budget, you know it’s important to save for your wants and pay for your needs. When setting your financial goals, it’s okay to plan on debt. The trick is to plan for a down payment as well. Paying cash only for purchases doesn’t always work in your favor long-term; you need to borrow to nurture a healthy credit history. By having a 20 – 50% down payment, you can build/diversify your credit history and have more budget friendly payments as your principle amount will be lower.
TIP: Depending on the value of the collateral, you may be able to get a better interest rate with a large down payment when doing a secured loan.
It’s time to tame your revolving debt
Sometimes revolving debt can get wild and out of hand, but it does a lot for building your credit history. Revolving debt is a loan or line of credit that stays open and allows you to “reborrow” the funds continuously. Typically these loans are credit cards but can also be open-ended loans such as Home Equity Line of Credits (HELOCs) or overdraft protection.
Not all credit cards are bad. In fact, if handled correctly, some can have major benefits. When you start or are trying to rehabilitate your relationship with credit cards, look for one that you can use in emergencies and for purchasing items you would buy normally. Once you receive your bill, pay it in full.
TIP: Did you know that your available credit plays a huge role in your credit score? Credit cards with a low balance are absolutely necessary to a healthy credit history. This one section of your credit score outweighs categories such as length of credit history, types of credit, and your number of credit inquiries!
Analyze your current credit card perks
It’s easy to get pulled into multiple credit cards based on their benefits. Is 25% interest worth the 10% you will save on your first purchase? Probably not. If you are looking at a rewards credit card, think about the following:
If the card seems like more of a hassle than it’s worth, consider closing it for a card that is more manageable, especially if it is high interest. If you must use a store credit card, only get one that can be paid off immediately after your purchase in the store.
TIP: If you already struggle with the temptation credit cards provide, try avoiding store credit cards or cards with high limits until you start to control your revolving debt. For more help or information, please speak with a financial counselor
Avoid dangerous debt at all costs
When you are in a tight spot financially, you may be tempted to go to a payday lender. These predatory institutions usually link your payments to your direct deposit and seem convenient. However, the short-term loans can be extremely expensive due to fees and high interest rates. According to the Consumer Financial Protection Bureau, a typical two-week payday loan can have an average APR of almost 400%!
Utilizing these services can lead to a debt snowball that is difficult to melt. These loans do not typically appear on your credit history unless they are in collections, so they do not help your credit score.
TIP: By using payday loans, you may make yourself too risky for conventional loans. Prior to seeking out a predatory lender when you are desperate for funds, speak with area financial institutions first to look for options. Many have no minimum loan amount so if all you need is around $100, they may be able to help!
Find your rapid debt repayment motivation
Will you stay on track if you pay the debt with the highest interest, therefore saving more money? Or do you like to see progress and prefer to pay the lowest debt?
Many financial counselors recommend paying down your highest-interest first, but do what makes you comfortable. Once you pay off your first loan, you can try the rapid debt repayment technique to quickly tackle your balances. This is done by taking the payment from the first loan paid off and adding it to another one of your loan payments every month. This is an effective way to pay off debt early without adding extra money to your payment budget.
TIP: Don’t forget to make saving a priority when paying off debt early! When you skip saving, you will continue to depend on debt when emergencies arise.
Pay your bills in a timely manner
If this is difficult to remember or you have difficulty paying your bills in full, try doing a bi-weekly automatic transfers or bill pay through your financial institution. If you receive your paycheck through direct deposit, your payments will be made before your funds are available. This will keep the payments manageable and ensure they are not forgotten. Doing so will help your credit and help build a good borrowing relationship with your lender.
TIP: Don’t rely on “grace periods” when making payments. This term refers to the policy that some, not all, lenders may have that gives the borrower a certain number of days past the due date to still make their payment without penalty fees. Always try to have your loans paid in full by the due date.
When your payments are a burden, consider debt consolidation or refinancing
Sometimes your payments can outgrow your budget and you need some help restructuring. Talk to your financial institution to see if there is a way to wrap all of your credit cards into one close-ended loan or refinance your car loan for a lower payment. This requires some creativity from your lender and discipline from you. Consolidation or refinancing will not be effective if you continue to spend beyond your means, especially if you are trying to pay off credit card debt.
If you want to know your options or where to start, contact your financial institution or a financial counselor to create a game plan.
Monitor your credit history
Research and sign up for the credit monitoring service that works best for you. Every month, check your credit history and ensure all of your information is reporting correctly. If not, contact each of the three credit bureaus to make a correction. Not only can this help you stay motivated, but you can catch identity fraud early as well!
TIP: When using a credit monitoring service, know that the “credit score” shown is usually an estimate and not your actual score. What you should look for is accuracy and progress in your credit history.