Debt Got You Down? Our Tips on Understanding and Reducing Debt

Debt got you down? We’re here to help. Mike Crews, Universal Banker III at Town and Country Bank, is spearheading a ten-part financial literacy seminar with the Springfield Housing Authority (SHA) to help residents obtain the knowledge needed to achieve their financial goals. During his October seminar, Mike focused on understanding and reducing debt by outlining common terminologies and debt reduction strategies.

Understanding Debt

One of the most intimidating parts of debt is all the confusing terminologies involved. Debt vs. credit: what do they mean? Debt, simply put, is money you owe. Credit is your ability to borrow money. Your credit determines how much money you can borrow from a creditor or lender.  While the ability to borrow money (credit) can lead to debt, that doesn’t mean you’ll absolutely go into debt. A credit card is an example of this. You have credit available to you, but debt doesn’t incur until you start spending the money. You’ll have the debt until you pay off your credit card bill. Vice versa, you can have debt without having any credit. If you borrow money to buy a car, you have debt. You likely can't borrow more money using that loan so you don’t have any credit through that loan.

Credit is an important factor in both short-term and long-term financial goals. You must have credit to take out a mortgage and any student loans or to get a new car. Your credit score helps lenders understand how much money you can borrow and if you’ll pay it back.

Once you have a loan, you'll need to be mindful of how you spend your future income. This practice is known as obligating future income. Knowing when your payments are due, how much they are, and how much you can afford to pay at that time may limit your choices on what you spend your future income on, but making regular payments on time is the number one way to avoid debt.

Reducing Debt

Life happens, unexpected issues arise, payments fall behind, and debt follows. Now what?

To begin planning on how to reduce debt, you first need to fully understand it. Who you owe, how much you owe, when the payments are due, how high the interest rate is, and why you fell behind in payments are all key factors in understanding how your debt piled up. Once you have the answers to these items, you can begin developing a plan for reducing your debt.

"There are many methods for paying off debt - everyone does it a little different,” says Crews, Universal Banker III at Town and Country Bank. “Not all types of debt affect finances equally. I enjoy working with our customers to find the debt reduction method that best fits their lifestyles."

There are two common strategies for reducing debt: The High-Cost Debt Method and The Snowball Method.

The High-Cost Debt Method, also known as Debt Stacking, means paying off the debt with the most interest first. Say you have student loans, a car payment, and a medical bill to pay. Most likely, the student loans are the most expensive and have the highest interest rate. Using the High-Cost Debt Method, you would pay off as much of the student loans as possible to alleviate the accumulating interest before chipping away at the remaining debt. The upside to this is that reducing high interest rates will allow you to save more money moving forward, which can be put towards smaller debts. The downside to this is that it requires a lot of money all at once and you’d still have to make your regular payments for all existing loans on time to avoid accumulating more debt.

The Snowball Method means paying off debt with the lowest balance first. In this case, you would pay the medical bill off first. Once that’s paid off, you can roll that money into making higher payments each month on the car loan. Once the car loan is paid off, you can roll that money into making higher payments on the student loans, creating a snowball effect. A big reason why this works is that seeing small debts disappear can be encouraging. You’re climbing down the latter, rather than leaping from the top. The downside is the accumulating interest on the largest loan, which can lead to paying more money in the long run.

With either of these methods, it helps to create a chart with all your debts laid out from most expensive to least expensive. On the left side, name who you owe the money to. Along the top, create sections for the total amount owed, the payment amount, the payment due date, and the interest rate. If you choose to use the High-Cost Debt Method, work from the top down. If you choose to use the Snowball Method, work from the bottom up. This provides structure and a visual payment plan. It’s important to note that these strategies work best if you don’t accumulate any more debt in the meantime. Both of these methods have their pros and cons, and deciding what method to use depends on your unique situation and financial goals. 

Keep Up With Our Financial Literacy Seminars

To keep up with topics covered in our financial literacy seminars with the SHA, check out our blog! Not sure where to start building your financial future? Visit us at one of our 12 conveniently located branches to speak with a banker about building a financial plan that’s right for you.