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We wrote this guide for you to understand why you should pay off your debt as soon as possible. We wanted to clear things up because too many people misunderstand what debt is.
According to the Experian, the total consumer debt reached $13 trillion in the last quarter of 2018.
- $291 Billion in Personal Loan
- $834 Billion in Credit Card Debt
- $1.27 Trillion in Auto Loan
- $1.37 Trillion in Student Loan
- $9.4 Trillion in Mortgage Debt
The good news is that you are not alone. But, the bad news is that you are paying a lot of interest on your debt. In other words, you are giving away money to your lender every month instead of using it to do the things you love.
What Is Debt?
We can define debt as money that you owe to someone else. You have to pay your lenders monthly interests on the money they loaned you. Thus, taking on debt can be risky if you don’t have a plan to pay it back. It is also pretty easy to underestimate the total amount of debt you have.
To better understand what debt is, we can further divide it into two categories – secured and unsecured.
What Is Secured Debt?
Secured debt relies upon collateral. It allows your lenders to reduce the associated risk by lending you money. So, if you were to default on the payment, the debt collector would seize your asset and sell it to pay back your debt.
For example: mortgage debt or car loans.
What Is Unsecured Debt?
Unsecured debt doesn’t rely upon collateral. But, you still have to repay what you owe even if you didn’t use the money to buy an asset. The debt collector might sue, which can lead to wage garnishment.
For example: credit card debt, personal loans, student loans, or medical debt.
How Can You Avoid Debt?
Some types of debt can crush you due to their high-interest rates. Thus, one of your financial goals should be to avoid those types of debt.
Credit Cards Debt
The average credit card interest rate is 15%, but it can be more than 20% for some borrowers. As a result, credit card debt is one of the most costly. Issuers often offer low monthly payments to keep you paying interests for years. So, add any extra money you can save to your required payment each month.
For example, let’s say you have a credit card balance of $10000, and you are making monthly payments of $300 on a 20% APR. As a result, it will take 4years and a total of $4094 in interest to pay off your debt. Now, let’s say you are making an additional payment of $200 to your debt each month. Thus, it will take you 2years and a total of $2030 in interest to pay off your debt. In other words, you will save 50% interest!
Payday loans might not look like a bad idea at first. But, if you can’t pay what you owe in the two weeks period, they become the worst type of loan you could get. Their average annual interest rates are 400%. Due to their short-term period, it might not be apparent when reading the contract, so be careful.
Why Should You Pay Off Debt?
Paying your debt sooner rather than later can have a lot of benefits. It can improve your life in many ways.
Make More Out Of Your Money
Being debt-free will allow you to increase your financial security. Since you won’t have to make payments every month, you will do whatever you want with this extra money.
For example, if you don’t already have an emergency fund, you can use this opportunity to build one. You can also make your extra money work for you by investing it. Start with low-risk savings accounts or mutual funds that track the U.S. stock market.
Reduce Your Stress Level
What about reducing your stress level to have more time to do the things you love. You won’t have to think about how to make your debt payment this month. Similarly, you won’t have to make time in your schedule to pay your debt every month. Paying down your debt will reduce your stress level.
Improve Your Credit Score
Paying off your debt will have a double benefit on your credit score.
Your credit utilization ratio is the amount of your credit balance over your credit limit. So, the more you pay off your credit balance, the less your credit utilization ratio will be. In other words, if you do that, your credit score will increase.
With a higher credit score, you will have access to better interest rates. That is when a great strategy is to consolidate your debt. Thus, there are two ways to do that – applying for a personal loan or do a credit card balance transfer.
- You can apply for a personal loan that has a lower interest rate than what you currently have. Then, you will pay off your debt using the money loaned.
- You can transfer a credit card balance to a new credit card that has a 0% APR for the first year. Then, your goal should be to reduce your credit balance as much as possible because, at the end of the first year, you will get a high APR.
How To Pay Off Debt Fast?
Depending on your current financial situation, you might want to handle your debt differently. But, if you aspire to pay off your debt as soon as possible, you should follow this five steps strategy.
- List all your debts from the smallest to the largest
- Find out what is the required payment you have to pay for each debt and make those payments
- Create a budget and discover how much money you can save
- Use this money as a payment to your smallest debt
- After paying-off a debt, use its required payment as an additional payment to your next smallest debt
At the end of this process, you will be debt-free!
You just read everything there is to know about debt. Now, we hope that you have a better understanding of it and that you will find the motivation to pay off yours as soon as possible.
In conclusion, you should look at debt as of last resort and paying it off should be your priority. Your wallet will thank you, and you will feel relieved. You will also enjoy all the things you love to do without taking on more debt.