A Financial Advisor’s 10 Tips to Reducing Debt
It might start out fairly innocent – a credit card purchase for $500. But if left unchecked, a small portion of debt can grow into a ball and chain, holding you back from positive cash flow, affordable financing for investments, and financial freedom.
As a financial advisor at Scarborough Capital Management, I’ve seen firsthand how debt can affect not only someone’s day-to-day cash flow but also their financial goals, their retirement, and their overall future.
A lot of people focus solely on their careers, their income-generating investments, and their savings – if they’re able to live comfortably, everything seems fine. While these are extremely important to building your wealth, making money is only one part of the financial planning picture. Reducing your overall debt should also be a top priority in your financial life. If you’re spending a lot of money paying off debt, not only are you paying more for a particular item than you may think (interest can add up quickly), but you’re using money that you could instead be investing and making work for you.
Debt Management: An Overlooked Financial Secret
Getting your debt under control might not be the most exciting financial endeavor you can think of. Nevertheless, loans and those thin pieces of plastic you own can destroy your finances if you let them.
Total consumer debt in America is more than $14 trillion, with more than $1 trillion in credit cards alone, meaning that the average American citizen carries more than $90,000 in total personal debt. As a financial advisor in Annapolis, MD, I strongly encourage my clients to reduce their debt – Maryland was ranked the fifth most expensive state in America, so it’s especially important to be on top of your debt to better manage your cost of living to maximize your wealth generation.
In my experience, here are 10 tips for reducing debt:
1. Stop Accruing More Debt
Your first order of business is to stop accruing more debt. Swiping your credit cards may have become a habit for you, and that habit must be broken. Use your credit cards for emergencies only. Leave them at home if that’ll help. Adding to your current debt only makes the outstanding balance bigger.
2. Decide What to Pay Off First
Having a strategy to eliminate debt can make the process more tangible. You can use a strategy that focuses on your debt amount, or one that focuses on the interest rate. Both methods are effective.
The Snowball Method: Pay Smaller Debts First
The snowball debt method pays down debt and builds your confidence at the same time. Using this strategy, make larger payments on your smallest debt balance first, and pay the minimum payments on any other debts. That way, you can maximize your payoff schedule and move to the next debt faster, mentally gaining momentum in the process.
The High-Interest Rate Method: Target ‘Bad’ Debt First
Debts with high-interest rates (also called bad debt) can take decades to pay off. To use the high-interest payoff method, prioritize your debts by their interest rates, instead of the amount. Credit cards can have interest rates between 15 and 20 percent, killing your cash flow. Therefore, paying off your high interest-rate debt first can eliminate balances that grow the fastest, lowering your overall debt expenses in the long run.
Choose the option that works best for your budget. Talking to a financial advisor can help.
3. Pay More than the Minimum Payment
If possible, do your best to pay more than the minimum payment. The minimum may give you breathing room in your monthly budget, but paying the minimum only can add years to your payoff schedule. Devoting any extra money you have to pay more than the minimum payment can help free yourself faster.
Making your payments bi-weekly is another strategy I’ve seen work.
When you make a debt payment, your funds are split between interest and principal. Interest is paid first, and typically accrues daily. Rather than letting your debt interest accumulate for 30 days between payments, split your regular monthly payment into two equal, bi-weekly payments (i.e. turning a $250 monthly payment into a $125 payment every two weeks). This can help your payment punch through your accumulated debt – only 15 days of interest rather than 30 – and reach your principal (what is actually owed) faster.
Talk to your financial advisor to calculate the effects of this strategy with your own numbers.
4. Don’t Accrue Late Charges
Not only do late fees increase your balance and use money that could’ve gone toward your debt, but they can also damage your credit score, forcing you to accept higher interest rates when you’re buying a house or a car, or refinancing.
That’s the ugly truth about debt: As a financial advisor in Annapolis, I’ve seen debt crawl its way deep into people’s financial lives, robbing them of financial opportunities in the future. Consider setting up an automatic payment on or before your due date, and nip those unnecessary fees in the bud.
5. Find Ways to Save
Saving money is an effective strategy at any stage of your financial life, but especially when undergoing a debt-payoff strategy. Any additional savings that you can obtain can be paid toward your debt, helping you dig yourself out of a financial hardship faster.
6. Create a Budget
Your personal budget is your blueprint for financial success. Though sitting down and thoroughly recording your monthly inflow and outflows isn’t the most fun activity in the world, it is essential for getting your finances under control. Start with your expenses. Jot down all of your fixed costs to get a ballpark of how your cash ends up at the end of the month.
For even more precision, look at your monthly bank statement. Counterintuitively, discipline is a precursor to freedom, and following a budget can be a great tool for developing discipline in your spending.
7. Consolidate Debt for a Lower Rate
There are no shortcuts to paying off your debt, but there may be minor improvements you can make. Consolidating your debt means combining separate debt balances, such as individual credit cards, into one loan, normally with a lower overall interest rate.
This, in turn, can make your debt payments easier to keep track of, with potentially a lower interest rate. The average credit card interest rate is 15.9 percent, while debt consolidation services offer an average interest rate on a two-year personal loan of approximately 10.36 percent, according to Federal Reserve data.
By consolidating your debt, you can potentially reduce your interest rates by roughly 30 percent on average. If you are considering debt consolidation, be sure to double-check the fine print, as some services offer a lower interest rate but may charge a hefty flat fee for the service.
8. Prioritize Needs and Wants
Once you make your monthly budget, see if there are any expenses you can cut or reduce. Take a look at your spending and separate your expenses between your wants and needs. If there are any expenses that are nice-to-haves and non-essentials, consider finding a cheaper alternative or cutting them completely. While this may seem extreme, carrying debt can cost you thousands of dollars in the long run, holding you back from affording luxuries in the future.
9. Establish Your Personal ‘Fun Money’ Account
Knowing how much you can spend on fun, discretionary items can help you develop financial discipline while providing some fulfillment of your wants and needs.
For example, after you’ve created your budget, say you have $400 a month leftover after paying all of your bills and debt payments. This tells you that treating yourself to dinner, or doing a bit of shopping, won’t damage your finances.
Similar to dieting, when you cut yourself off from everything that tastes good, there’s a better chance you’ll stray from your plan altogether. Consider setting aside money in a small “fun” account so you can make positive steps toward financial freedom while maintaining your sanity.
10. Talk with a Financial Advisor
Your financial advisor is a great resource for planning and implementing a debt-payoff strategy. Financial advisors can create a fully comprehensive financial plan that encompasses a blueprint for your spending, saving, and debt paydown, as well as a strategy for your investments, retirement planning, and any other goals you have. All of these facets of your financial life should be in alignment, and your financial advisor can help make it happen.
Even high-net-worth individuals can find themselves spending more than they should.
There are numerous success stories of people who have eliminated massive amounts of debt, and by utilizing these tips on your own, you’ll be on your way to becoming a success story yourself.
If you’re not currently working with a financial advisor or feel like it’s time for a change, contact us. We’re here to help.