Paying Off Debt - The Flip Side of Borrowing Money
Paying your bills, loans, and other debts is a significant, recurring financial activity. Whenever you borrow money or take on a debt, it's essential to borrow money wisely, keep your monthly payments affordable, and have a clear understanding of how long your payments will last.
According to research by the Center For Financial Services Innovation,
"30% of Americans say that they have more debt than they can handle."
Are you one of them?
Before you took on debt, did you think about how the monthly payments fit into your budget? Did you carefully consider if you can afford to make the payment every month? If something unexpected happened and your income was reduced for a period, do you have an emergency fund to cover your payments, so you don't run up more debt or default on your payments?
Can You Afford to Pay Off Your Debt - Check Your DTI
Our financial health survey asks you about your debt load and your credit score. Those are both critical indicators that lenders use to see if you can afford new debt. However, they are also tools you can use to check if your current debt level is realistic and sustainable.
Our Debt to Income Calculator makes it easy for you to analyze what you spend to pay off various types of debt. If too much of your income is going to pay off your debt, then you are going to find it hard to pay your other bills, especially emergency bills, and you won't be able to put money into retirement savings.
Five Debt Payoff Strategies in a Nutshell
There is no single, one-size-fits-all solution for paying off debt. Your unique combination of income, spending habits, financial goals, and debt levels are important for you to find the best debt pay off option.
Your menu of choices to pay off debt is limited. There are only a few common debt relief solutions, as follows:
Bills.com provides in-depth information about each of the solutions, but here is a brief explanation of the common ways to pay off debt
Optimized Payments is a Do-it-Yourself method, where you pay off debt quickly and improve your credit score. It is a great option if you can afford your current payments, are able to pay more than the minimum payments on your debts, and want to become debt free in a short amount of time. If you can stick to a budget and make the same total payment each month, you will realize significant interest savings when compared to making the minimum required payment on each account.
The Avalanche method, which focuses on paying off your highest interest debts first. In this plan, organize your debts from the highest interest rates to the lowest.
The Snowball method focuses on paying off your smallest debts first. This is the method Dave Ramsey recommends. Under the snowball strategy, you'll pay the required minimum amount for each account and then use the remaining funds paying off the debt with the lowest balance.
Pay a constant minimum, where you will make the same scheduled payment as you are making today for each account until it is paid off. This step alone provides significant benefits compared to making minimum payments.
If you have sufficient equity in your home, then you can choose between a cash-out refinance and a home equity loan. Debt consolidation with a cash-out refinance involves paying off your current mortgage and rolling the debt you want to pay off into your new mortgage.
Mortgages run a long time. This option stretches out your debt payments for the life of the mortgage. Because the debt you consolidated into your mortgage took you so long to pay off, even if your interest rate is lower on your mortgage than on your credit cards, you will pay more in total interest. The benefit is a lower monthly payment, but that is only significant if you really needed a lower payment to afford all your expenses.
Mortgage rates are an important factor. If you have reasonable rates on your current mortgage and don't need to reduce your monthly payment, then look for a home equity loan. However, if you can refinance into better rates or need to reduce your monthly payment, then check out a cash-out refinance mortgage.
A personal debt consolidation loan is an unsecured loan that allows you to make one payment on all of your credit card debt and outstanding bills. In general, the payoff period is two to five years.
The interest rate varies, and your credit score is a crucial part of the lender's approval decision and the interest rate you will receive.
A debt consolidation loan puts you in a fixed payment plan. It allows you to pay off debt in affordable payments. The amount you save depends on the interest rate you get and the rate on the debts you consolidated.
Credit counseling offers a manageable way to becoming debt free with minimal impact to your credit score. A counselor will review your financial situation and, if appropriate for your situation, will create a debt management plan where you pay a single fixed monthly payment. Funds are automatically distributed to your creditors by the credit counseling service, which takes a monthly fee.
Typically, a debt management plan will provide a lower interest rate for each creditor than you are paying today and take approximately five years to complete.
Debt settlement provides consumers with severe financial hardships an alternative to bankruptcy. In debt settlement, money is saved up (instead of making current payments), and the saved funds are used to pay your creditors after the settlement firm negotiates with creditors to settle your debt for an amount lower than you owe. This strategy can offer significant savings and a quicker way to becoming debt free, though it is not for everyone.
While you are working to build up balances, you are not paying your current creditors. Consequently, debt collectors may call you, often quite aggressively, and there is a risk of legal action. Since you are missing payments, your credit score will be impaired for at least the duration of the debt settlement program, which typically runs between three and four years. A good debt resolution firm will work hard to lessen these risks, but they are present until all your debts are settled. Debt settlement can be a great choice to resolve your debts at a low cost in a short amount of time while avoiding bankruptcy but requires perseverance to be successful.
Pay off Debt - An Example
Jay and Destinee think of themselves as a typical family. They are in their mid-50s and have enjoyed 22 years of marriage, with ups and downs. They are in a pretty good financial situation, but recently used savings and then took on debt to pay for their kids' college expenses and some much-needed home repairs. Here is a brief breakdown of their debt:
- Mortgage: $325,000 (Home is worth $524,000 and they refinanced about 4 years ago at 4%)
- Credit Card Debt: $14,000 (Credit Line is $20,000 and their interest rate is about 12%)
- Parent Student Loan ($12,000 for their two kids and they won’t need anymore).
Jay and Destinee don’t plan on taking out more loans now, but they feel that they could improve their situation. They decided to analyze their situation with the Bills.com Debt Payoff Calculator. They answered some very easy questions about their financial situation and goals, which included paying off their debt quickly and improving their credit score.
Here are the results:
- Take out a Personal Loan to Consolidate their Credit Card Debt and Student Loan Debt. With their good credit, they can consolidate the $32,000 into one payment at about 8% interest. The monthly payment would be $782 which is affordable. Their credit score would improve over time as they lower their credit utilization.
- Optimize their Monthly payments: Instead of consolidating debt Jay and Destinee could more aggressively pay off their credit card debt using either the snowball or avalanche method. Their credit would slowly increase as their debt is paid off. Ideally, they would include the parent loan into their strategy.
- Cash-Out Mortgage or Home Equity Loan: Since they have equity in their home, the DeRoys could consider a cash-out refinance mortgage with a lower payoff period, for example, 15-years, and set up one monthly payment for all of their debt. Since mortgage rates are constantly changing, they need to see how today’s 15-year rates match up with their current interest rate.
Use the Bills.com Debt Payoff Calculator
Find the best way out of debt by using the Bills.com Debt Payoff Calculator.
You answer 12 short questions. Our innovative Debt Payoff Calculator learns your goals and priorities in paying off your debt. It weighs your preferences to find you the best debt solution from the different debt help options available: do-it-yourself, debt consolidation, consumer credit counseling, debt settlement, and bankruptcy.
The Debt Payoff Calculator:
- Explains how the various pay off de options works.
- Lays out each option's pros and cons.
- Makes clear why you were offered one particular solution over another.
- Provides accurate estimates for each solution's monthly payment and for the total cost to pay off your debt.
- Recommends a solution only if it has an affordable monthly payment.
Affordability is crucial. No debt solution works if you can't afford the payment and drop out. What's affordable to you may not be affordable to someone with the exact same debt.
The Debt Payoff Calculator asks you how much you can afford to pay each month. Only a solution that fits your budget will be recommended.
Use the Debt Payoff Calculator today. You only have your debts to lose.