Even for high earning young professionals, personal debt can weigh heavily. It can affect not only financial stability and lifestyle but mental well-being and overall quality of life. That’s true perhaps now more than ever. Since 2022, the Federal Reserve has raised rates 10 times as it aims to rein-in stubborn inflation, impacting everything from mortgages to car loans and credit cards. Further complicating the debt landscape is the expiration of the student loan payment pause on September 1.
That said, with proper planning, discipline, and determination, it is possible to tackle debt and pave the way for a debt-free future. This article will describe the current debt terrain and explore effective strategies and practical steps to help individuals navigate the path to debt repayment. In so doing, individuals can regain control of their financial situation and better position themselves for long-term asset accumulation.
The Current Debt Picture
No one knows precisely what the Federal Reserve is going to do over the coming months. But based on the latest guidance and macroeconomic trends, most experts project at least two more rate hikes in 2023. That would move the Fed’s key bank lending benchmark to between 5.00% and 5.25%, a level not seen in decades. The results will reverberate through the financial markets.
First, if you are looking to get a new mortgage or refinance an existing one, a tough situation is about to get even tougher. National 30-year fixed rates are already approaching 7.5% and could reach 8.0% by year-end. This will put downward pressure on both new mortgage applications and prices in the housing market. It also means that fewer existing homeowners will be looking to move since they don’t want to lose the lower mortgage rates they secured years ago.
Similarly, consumer debts will become even more burdensome to carry. The average variable credit card interest rate is already over 20% for most, and many store credit cards are now set at above an incredible 30% APR. These figures are likely to rise even further in the coming months. Finally, while the semi-conductor shortage that led to a historic shortage of cars post-pandemic has largely been reversed, rates on new and used car loans continue to increase. As, a result, even shoppers with excellent credit are moving away from banks toward the more competitive rates offered by local credit unions, with the latter often 2-3% lower.
Assess Your Debt and Create a Budget
Now that we’ve painted a picture of where rates are and where they are probably going, the first step in tackling your own personal debt repayment is to assess your current financial situation. Gather all of your applicable statements, including those for student and personal loans, credit cards, mortgages and HELOCs. Make a comprehensive list of your debts, noting the outstanding balances, interest rates, minimum payments, and due dates. This assessment will give you a clear picture of the magnitude of your debt and help you prioritize the repayment tactics which we will be discussing momentarily.
Since it’s the figure that many lenders use to figure out how much you can afford to spend on such large purchases as homes and cars, you should also calculate your debt-to-income ratio. Here’s how:
- Add up your month’s debt payments, such as your mortgage, auto loans, student loan, and credit card payments.
- Divide your total debt payments by your monthly income.
- For instance, dividing total monthly debt payments of $6,000 by a monthly income of $15,000 would yield a debt-to-income ratio of 0.40.
Do the same thing with just your consumer debts (excluding your mortgage). Most lenders want to see you below 36% on the first number and 20% on the second. If you’re above those targets (or even if you’re below them but want to cut your debt burden, further) we’ll be providing some tips. For now, make sure you know where your ratios stand and your credit score. You can obtain a free copy of your credit report every 12 months at AnnualCreditReport.com.
Next up, recognize that developing a realistic budget is essential for any effective (and lasting) debt repayment plan. Evaluate your income and expenses, categorize your spending, and identify areas where you can reduce or eliminate unnecessary expenses. Allocate a specific amount of money each month toward debt repayment, ensuring that it aligns with your financial goals. A budget will help you stay on track, track your progress, and make adjustments as needed.
Student Loans: Know Your Options
This is often a big one with the young professionals with whom we work since their premium incomes can go hand-in-hand with the time and money they invested in their higher educations. The situation is even more complicated, now, since the Federal student loan payment pause that has been in effect since March 2020 will expire on September 1, 2023. You need to know your options to take advantage of the best repayment plan for your unique situation.
As of the time of this article, interest will begin to accrue on September 1 with the first payments due for most student loan services in October. Between now and then, be sure you (re)locate your username and password, log-in to your account, and note your payment amount and current loan terms. If you’re not already on auto-pay, consider setting that up as most servicers provide a 25 basis point discount for enrollment. Next, you’re going to want to investigate whether an income-based payment plan is right for you. Lost amidst the pandemic pause and controversy surrounding President Biden’s proposed executive action to forgive $10,000-$20,000 of debt for many borrowers, the Department of Education also unveiled a new income-based repayment plan called SAVE. The plan exempts even more income from the monthly repayment calculation and stops the capitalization of unpaid interest.
The result will be that even six-figure earners could end up paying less my enrolling in the income-based plan. Studentloanplanner.com features a helpful discretionary income calculator on their website to help you get started. From there, borrowers will only pay 5-10% of their income for 20-25 years, depending on the loan type(s). For example, a family of 4 earning $125,000 would pay only $239 per month toward undergraduate loans. And since the discretionary figure uses adjusted gross income, borrowers have the option to lower their monthly loan payments by increasing their 401k contributions.
Action Steps To Slash Your Debts
1. Start With A Strategy: Not all debts are created equal. Prioritize your debts by considering factors such as interest rates, outstanding balances, and the impact on your credit score. The two most common strategies for prioritizing debt repayment are the snowball method and the avalanche method.
Snowball Method: Start by paying off the smallest debt first while making minimum payments on other debts. Once the smallest debt is paid off, use the money previously allocated for that debt to pay off the next smallest debt. This approach provides a psychological boost as you witness tangible progress and build momentum.
Avalanche Method: Focus on paying off debts with the highest interest rates first, regardless of their balances. By eliminating high-interest debts, you minimize the overall interest paid and accelerate your journey to debt freedom.
Each method has its benefits and drawbacks and it’s not for us to tell you which method to adopt. What matters is that you have a plan that works for you.
2. Negotiate with Creditors: If you’re struggling to make payments or facing financial hardship, it may be beneficial to negotiate with your creditors. Contact them to explain your situation and explore options such as reduced interest rates, extended payment terms, or debt settlement plans. Creditors are often willing to work with you to find mutually beneficial solutions, provided you communicate your circumstances honestly and proactively.
3. Cut Expenses: Reassess your expenses and identify areas where you can cut back, such as dining out less frequently or downgrading subscription services. Redirect the extra funds toward debt repayment to expedite the debt repayment process. Every expense reduction, no matter how small, adds up over time and contributes to your debt repayment progress. Remember, cutting expenses is a temporary measure to help you achieve your financial goals. Once you’ve paid off your debts, you can reassess your budget and reallocate the funds towards savings, investments, or other financial goals.
4. Supplement Income: Increasing your income can significantly accelerate debt repayment. Consider monetizing your hobbies, freelancing, or finding other ways to generate additional income. Make a list of your personal and professional skills along with your assets. Remedies could be as simple as renting unused space. We provided additional ideas for young professionals to supplement their income last month.
5. Consolidate and/or Transfer Debts: One of the primary advantages of debt consolidation is the opportunity to secure a lower interest rate. If you can obtain a consolidation loan or transfer high-interest credit card balances to a card with a lower interest rate, you can significantly reduce the interest charges. Check around for cards with a 0% interest period. Some listings on Nerdwallet allow borrowers to pay no interest until 2025. With a lower interest rate, more of your payment goes towards paying down the principal balance, allowing you to repay the debt faster.
The journey to debt repayment can be challenging, and it’s crucial to stay motivated along the way. Set realistic goals, celebrate milestones, and remind yourself of the benefits of becoming debt-free. Additionally, consider seeking support from family, friends, or online communities dedicated to debt repayment. Surrounding yourself with like-minded individuals can provide encouragement, accountability, and valuable insights.
Tackling debt repayment requires commitment, discipline, and a well-defined plan. Remember, each small step counts, and with perseverance, you will overcome your debts, achieve financial freedom, and create a more secure and prosperous future. Still have questions? Feel free to reach out to us here at Magellan Financial for a complimentary consultation.
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