Did you know that the mean credit card debt of U.S. households is about $5,700, according to Value Penguin? Texas ranks number 21 with an average credit card debt of $7,692. Interestingly, Alaska residents have the highest average debt, and Ohio residents have the lowest. Now is the time to get wise about credit and credit card debt. October 17th is Get Smart About Credit Day, a day to share awareness about personal finances and using credit wisely. Let’s take a look at some smart ways to pay off debt.
Evaluate your debt
Some debt is healthier than others. Bad debt may include such items as high-interest credit cards and payday loans. Good debt usually includes low-interest loans that help you increase your income or net worth. But even too much good debt can be unhealthy. When paying off debts, prioritize your debts in order of importance. You may want to pay your mortgage and car payments first, followed by the highest rate debts next. Remember, purchasing clothes, groceries, and fuel on credit cards can be unhealthy; interest rates can be high if you do not pay off the bill each month. More on debt payment strategies later.
Set a goal
To pay off bad debt, you need to set a goal. Once your debts are prioritized, set a realistic timetable for paying each off. It takes patience and discipline to pay off debts. It can be easy to rack up debt, and then take quite some time to pay it down. Set your goals and stay the course.
Focus on needs
While paying off your credit cards and other loans, you may need to cut back spending in several areas to make the necessary payments. Decide what you really need and what you simply want. For example, you may want a new outfit for work, but you may not actually need it. You may need to pay for your child to have new shoes instead. Take stock of the true needs.
Make a budget
While focusing on your needs, set a budget for each month. A rule of thumb is to set your budget to 50/30/20. Let the first 50 percent of your monthly budget go towards your needs such as housing, groceries, gas, utilities, insurance, and childcare. Then, the next 30 percent may go towards wants and the remaining 20 percent to savings and debt. While I agree with this formula, if you are focusing on paying off debt, I recommend dedicating a higher percentage to paying off debt and cutting way back on wants. Once your debts are paid, you can add back into your budget a higher percentage to the “wants” category. Setting a budget will also help provide you a timeline for paying off debt.
Be strategic in paying debts
There are two schools of thought on paying consumer and credit card debt strategically. A popular concept is to pay the minimum payment required on the lowest interest cards and pay a larger amount on the cards and debt with the highest interest rates. Then, once those debts are eliminated, you can use the extra money to pay off the next highest interest rate debt, and so on.
Conversely, another option is to pay the debts with the smaller balances first. It can be a tremendous psychological boost to see debt paid off and crossed off your list. Then, you can focus on the next debt until all are paid down.
While there is more than one way to pay off your debt, the goal is to eliminate unhealthy debt, and sooner rather than later. Use this October 17th as a launching point to focus on getting smart about your credit.
Claudia Mollerup-Madsen is Vice President and Financial Advisor with the Wealth Management Division of Morgan Stanley in Houston.