For some, the dream of a debt-free life is a reality.
A new GOBankingRates survey of more than 1,000 adults found that over one in four Americans — about 27% — don’t owe a single lender a single dollar. But on the flip side of that bright spot are the nearly three out of four people who do.
“This alarming rate of debt can be attributed to several factors, including rising housing costs, high medical bills, student loans, and personal financial mismanagement,” said Tim Doman, an investment analyst, former private equity investment fund executive and the newly appointed CEO of TopMobileBanks. “As a result, many Americans are unable to pay off their debt and often turn to more expensive borrowing methods, like credit cards, to make ends meet.”
Let’s examine the issue of debt in America as a whole and how it pertains to the survey results.
Nearly one in four people count a mortgage among their debt obligations. Presuming it’s a fixed-rate loan with manageable interest, home loans aren’t toxic debt and should be at the bottom of your list of priorities. In fact, many experts think you’d be better off using that money to pursue investment returns that could outpace your mortgage’s finance charges.
“It’s certainly a balance when considering saving versus paying down debt,” said California Bank & Trust chief financial officer Chikako Tyler, who suggests eliminating toxic loans and building an emergency fund before even considering extra mortgage payments. “Then, if you have fixed-rate loans, such as a mortgage with a lower interest rate than what you can earn in safer investments, you’ll want to evaluate those tradeoffs carefully.”
Driving and Learning Aren’t Cheap, but They’re Manageable
Another one in four have auto loans, which currently charge an average interest rate of just over 6%, according to Motor1. The 19% who have student debt pay less than 5% interest on federal loans — that’s cheap money nowadays — and even private lenders charge students an average of just 7.15%, according to Forbes.
While it would be nice to own your car and your education free and clear, both can go on the back burner with your mortgage if your rate is in the mid-to-high single digits — chances are good that you have more pressing priorities.
“It is important to focus on paying off high-interest loans and credit card debt first, as these will be more expensive in the long run,” said finance expert Linda Chavez, founder and CEO of Seniors Life Insurance Finder. “After this, it is wise to focus on any remaining consumer debt such as car loans or student loans.”
Credit Cards Are the Great American Wealth Killer
Of those who reported having debt, nearly half — the largest percentage by far — hold revolving credit card balances.
Unless you have a payday loan or some other dangerous short-term debt with a triple-digit APR, paying down your plastic should almost certainly be your top priority.
“I advise our customers to tackle high-interest debt first,” said Vincent Cheung, co-founder of High Income Source, a financial services platform for small businesses and entrepreneurs. “So that would be your credit card debt, and then moving on to other types of debt with lower interest rates.”
Credit card debt has long been one of the greatest roadblocks to wealth-building in America, but the Fed’s ongoing rate hikes have only increased the urgency. According to Forbes, the average credit card APR is now a crushing 24.1%.
Personal loans are less toxic than credit card debt because they charge fixed simple interest instead of variable compound interest — and they’re also usually cheaper.
“Personal loans generally have lower interest rates than credit cards,” said Richard Barrington, a financial analyst for Credit Sesame. However, “generally” is a broad term.
According to Forbes, current personal loan rates vary from 4% to 36%. On one end of that spectrum is a rate that would be excellent even for a mortgage. On the other, you’re approaching loan shark territory. Their more forgiving financing structure can make good personal loans a smart strategy for consolidating scattered credit card debt — but not if you’re paying 36 cents for every dollar you borrowed.
Now that you know which lenders to pay first, you’re probably wondering how to come up with the money.
That, of course, is the hard part — but it will only get harder the longer you wait.
“List all of your essential budget items — food, rent or mortgage, transportation, utilities, etc.,” said Aviva Pinto, CDFA, CDS and managing director of investment advisor firm Wealthspire. “Put down what your income is and subtract the essentials to see how much you have left over. With the amount left over, start putting aside money to pay down the debt and eliminate extra activities until you are debt free.”
Pinto’s belt-tightening examples include:
- Eat in more often instead of going out to dinner
- Buy a bottle of wine or a six-pack of beer instead of drinking at a bar
- Eliminate clothing and accessory purchases until the debt is paid off
- Participate in free local activities instead of taking another vacation
- Make homemade gifts instead of spending money on expensive presents
“There are many ways to cut back,” said Pinto. “But you first have to be aware of how much you have overspent, put together a leaner budget and get yourself back on track.”
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