By LISA SMITH
April 20, 2021
Being in debt can be a significant obstacle to reaching your financial goals. According to the Federal Reserve, Americans collectively owed $14.56 trillion in debt as of the fourth quarter of 20201. Between credit cards, student loans, car loans and mortgages, it's easy to find yourself trapped in what feels like a spiral of debt.
- Getting caught in a spiral of debt often happens over time, rather than overnight, and breaking the cycle may take time as well.
- Student loans, credit cards, car loans, personal loans and mortgage loans can all contribute to the debt pileup and it's important to prioritize how you'll pay these obligations off.
- Ending the debt cycle requires a debt repayment plan but it also means reexamining the behaviors and attitudes about money that lead to debt in the first place.
- Nonprofit and for-profit debt relief services can help you get back on track financially, though they may not offer identical services.
Climbing out of debt and creating financial stability is challenging. Fortunately, there are some strategies you can implement to improve your financial situation and break the debt cycle for good.
How the Debt Spiral Begins
For many people, the slide into debt begins with student loans. An estimated 43 million Americans have student loan debt, with an average balance of just under $40,0002. Unfortunately, student loans may be a necessity to pay for an undergraduate or graduate degree as tuition costs rise year over year.
Because paying for college or technical training in cash is unfeasible for most people, education loans are the only choice. The downside is that taking out a loan immediately compromises your personal balance sheet. While you're in school, you're accumulating debt at a time when you probably do not have enough income to make even a single loan payment.
Note: Parent PLUS loans belong to your parents and aren't your debt but any student loans they cosign on your behalf belong to you equally.
You may also be incurring other types of debt in your 20s. Credit cards, for example, can help cover the daily costs of living while you're still in school or even after as you begin your career. While your loans are accruing interest, credit cards ante up by charging significantly higher interest rates than those on the school loans, putting you even deeper in debt.
When you finish school, debt spending is further reinforced if you live in an area where you need a car to hunt for a job or commute to work. This results in a visit to the auto dealer, where you will find yourself confronted by a salesman who cheerfully asks: "What size monthly payment are you looking for?" By the time you leave the dealership, another debt has been added to your burden.
A home mortgage may come next. Soon, the percentage of income dedicated to making monthly payments becomes overwhelming. To reduce the burden, you take out another loan in the form of debt consolidation. While bundling together one's high-interest debts and refinancing them at a lower interest rate sounds like a smart idea, the reality is that most people end up even deeper in debt within just a few years. As soon as their monthly payments decline, their rate of spending increases.
A few rounds of debt consolidation later, many people find that so much of their income is going to pay outstanding debts that they can no longer stay current with other expenses. Eventually, this could result in a damaged credit score, which leads to an inability to borrow at low-interest rates. High-interest rate loans and credit card payments further restrict cash flow and can even lead to bankruptcy. Although bankruptcy may provide a means to reset one's finances and start over, often it merely acts in a manner similar to debt consolidation, marking the beginning of another debt spiral.
Warning: Certain types of loans, including payday loans and auto title loans, can lead to a dangerous cycle of borrowing in which you may incur debt at triple-digit interest rates.
Break the Cycle of Debt
If you're ready to escape the debt spiral, the first step is to stop borrowing money. Credit cards are often the lead culprit in creating consumer debt, so that means putting the plastic away. Pay in cash, write a check, or use a no-fee debit card to make your purchases. This way, you will see how much you are spending and when the money runs out, you won't be able to spend more.
Next, you should take a close look at your income and expenses. While many people chafe at the idea of living on a budget, the reality is that everyone does (unless they've got an unlimited income). If you just can't handle the idea of tracking every penny that you spend, it's still a good idea to review your income periodically and compare it to your expenditures. At the very least, you will figure out whether you are shelling out more than you are bringing in.
Reducing your expenses by a meaningful amount can help speed up your debt repayment plans. Whether this involves big or small lifestyle changes depends on what you're most comfortable with and how quickly you want to pay off debt. For instance, housing and transportation are two of the biggest costs for most people. Moving to a less expensive home or even changing cities is often a way to make a meaningful and substantial reduction in your expenses.
Similarly, trading in your car for a less expensive vehicle can result in hundreds of dollars per month in savings when your car and insurance payments, and monthly gasoline bills are reduced. Or, if you live in a major metropolitan area with a public transit system, you may be lucky enough to do away with a vehicle--and its associated expenses--altogether.
Cutting back on discretionary spending is the next step in the process. This step is often the most challenging for people who don't like to keep track of where their money goes each day. One way to make it easier is by changing how you pay for things. The simple act of paying with cash rather than credit can help you become more aware of how much you spend and how much you have left in your pocket.
Create a Debt Repayment Strategy
If you've reviewed your spending and determined how much you can afford to pay toward debt repayment each month, the next step is choosing a repayment method. There are two options you can try: the debt snowball or the debt avalanche.
The debt avalanche is the most mathematically logical method since it requires you to pay off your highest interest debts first. This will result in the most financial savings over time but if you have large balances on your accounts it may take a long time before you feel like you have made any progress.
If that approach seems too challenging you could try the debt snowball instead. This involves paying as much as you can toward the debt with the lowest balance first while paying the minimums toward all your other debts. As you pay off a debt, you roll the payment amount over to the next debt on the list.
The debt snowball can give you a quick win if you're able to pay off one or two small debts right Once you've paid off one debt, you likely will be inspired to pay off the next one and the one after that. Although this approach isn't the most logical, it provides faster progress which can encourage your new habit.
Tip: Consider ways to make your debt less expensive, such as taking advantage of a 0% balance transfer credit card offer or consolidating debts into a low-interest rate personal loan.
The Next Steps
As you get into the groove of paying off your debts and sticking to your monthly budget, one of your goals should be to create a financial surplus each month. This is money you have left over after all your regular bills are paid and you've made adequate payments to your debt.
Once you reach a point where you have a surplus each month, it's time to put that surplus to work. A good place to start is by giving some of that money to yourself to save, not to spend. Instead of spending that surplus cash, stash some of it away for a "rainy day."
It's the "pay yourself first" concept in action. Rather than using the money to buy more stuff, setting that money aside creates an emergency fund that you can tap into when you need money in a hurry. If that rainy day arrives and you do need to spend the money, replace it as soon as possible. Ideally, you'll want to have enough money stashed away to cover at least several months' worth of expenses. If that seems like a big number, don't be discouraged. Setting aside an extra $50 is a great place to start.
Consider stashing your rainy day fund in a high yield savings account to earn a competitive interest rate with minimal banking fees.
Once you have fully funded your emergency savings account and your debt is under control, you can turn your attention to other financial goals, such as saving for retirement or your child's college education. If all of this feels simply too overwhelming and you don't think you can break the debt spiral alone, you may consider getting help from debt relief services.
Debt relief companies can help you explore different options for managing and repaying debt, including debt consolidation and debt settlement. Take time to research and compare the best debt relief companies to find the one that offers the best combination of services and cost for your situation.
Important: Don't pay any upfront fees to a debt relief company without having a written agreement about what they'll do for you first. And if a debt relief company makes promises that seem too good to be true, they probably are.
Ultimately, Perseverance Pays Off
To break the debt spiral, you'll need lots of patience. Any approach that motivates you to take action and stick to your plan is worthwhile. Remember, it took years (perhaps decades) to build up those outstanding balances. Recovery will be a similarly slow process.