Three Ways to Deal With Debt?

Welcome to the Weekly SUMmary - 01/22/2021

With a pandemic, government spending, and administrative changes, debt has been a hot topic of late. Although nothing has been solidified, there is some discussion that student loans may be forgiven on some level. Although this may come to fruition, I believe the best way to ensure a better financial future is to take control of your debt as many "forgiveness programs" have stipulations (must be federal loans, must have served the public for a set amount of time, must have made so many payments, etc.)

Three ways to deal with debt immediately, are:

1. Stop using debt, stop spending, pay off everything asap.
   • This is by far the most painful way of handling debt, AND the most effective, AND quick.
   • I would most closely compare this situation to a last ditch effort prior to bankruptcy where the courts will place orders on how one can spend their money, including contributions to retirement accounts, additional debt (home/auto loans), etc.
2. Pay off your highest interest debt first.
   • I believe this is the method most financial professionals would advise* as it is the way, if done properly, to pay the least amount in interest over the life of the debt.
     • Let's use a VERY basic example, assuming no additional payments, only lump sum payments, and simple interest.
       • You have three accounts, each with a $10,000 balance. The interest rates are 20%, 10%, 5%. If no payments were made in one year, the accounts would accrue $2,000, $1,000, and $500 interest. So, if you were to pay the account with 20% first, the total interest on the other two accounts would be $1,500, vs the $3,500 if nothing had been paid. This $2,000 savings is more than the other debt combined!
3. Pay off your lowest balances first.
   
   • This strategy is also typically successful for the psychological effect it has. When you pay off a low balance debt, it no longer accrues any interest, and is a sense of accomplishment. An example of this would be accounts of $10,000, $5,000, and $1,000. If one is able to pay off the $1,000, they have now paid off 1/3 of their debt accounts, and can focus on the other debt payoff.

These are the broad, basic options for paying off debt. Regardless of which choice is made, the best way to tackle debt is to "roll" whatever payments have been made on accounts as they get paid down into payments for other accounts. This example would be, if you are paying $900 total or $300 towards three separate accounts, and one of them is eliminated, roll the $300 payment into another so that instead of a total of $600 or $300 on two separate accounts, pay $600 on one account and $300 on the other, to continue paying $900 to all debt. If income increases during this time, a great way to expedite debt paydown is to allocate all of that to current debt. To add to this previous example, you receive a raise of $100/month. Instead of $900/month going toward debt, put the additional $100 for a total of $1,000 toward debt.

Remember, this is a temporary pain that will eventually lead to more enjoyable goals or uses of your finances. Once this debt is paid down, maybe take 2/3 or 3/4 of what was being paid toward debt for savings or retirement contributions. The other 1/3 or 1/4 could be contributed to an Emergency Fund/Cash Reserve account to accumulate toward unforeseen issues (home/auto repair, medical needs, etc.) or if these funds are not needed, then some of the funds accumulated could go toward a vacation or other item that has been on your "want" list.

*As always, this should not be construed as advice, but as educational in nature. Although "most" was used, each individual situation is different and should be treated as such. Please discuss with your advisors/consider all options/research prior to making any decisions.

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^_(01/21)