Dealing With Debt
Thousands of Americans find themselves in debt. According to statistics obtained by the federal reserve, total amount of consumer debt in the United States stands at over $2.5 trillion dollars. That works out to about $8,100 in debt for every man, woman and child that lives here in the US. In this module you will do the following:
- Understand what debt is
- Learn a strategy for attacking debt
- Understand the steps to take once you are out of debt
Part 1 - Understanding Debt
There are many different ways that people can get into debt. The most common and most dangerous way to get into debt is through the use of credit cards. Credit cards often carry extremely high interest rates that make it nearly impossible for people to completely pay them off. There are close to 200 million credit cards in the United States. Americans currently carry over $1 Trillion in credit card debt. This works out to over $6,000 in credit card debt per cardholder. Credit cards are not the only type of debt out there. People can find themselves burdened with home mortgages, student loans, car loans, medical bills, or other forms of debt. Below you will find a list of commonly asked questions about debt with simple straightforward answers provided.
Is it ok to carry a credit card?
For most people it is just fine to carry cards if you have a little bit of self control. Credit cards offer us convenience, an emergency fund, and in some cases even reward points. It helps to stay disciplined if you follow the the budget that has been created for you. You can find more information about deciding if credit is right for you on our guide to credit page.
Is there such a thing as a good debt?
Most people agree that there are types of good debt. For example, many people are burdened with student loans, but if it helps achieve their career goals and provides a well paying job, it is probably well worth the debt. A home or car may also be a good long term investment for an individual or a family. However, high interest credit cards should only be used as a last resort. It is important to budget for all expenses and have a plan for paying loans back before you take them out.
What is the difference between secured and unsecured debt?
Secured debt is something that is backed by an asset. Common examples of this include a home or a car. Unsecured debt is debt that is not secured by any asset. For example, when you purchase groceries with a credit card, there is not an asset that the bank can take from you if you do not pay your bill. Unsecured debts usually come in the form of credit cards or other unsecured bank loans. They usually carry with them extremely high interest rates. You can find more information about the topic by clicking here.
How much debt is too much?
There is no simple answer to this question. It will vary from person to person and from one situation to another. It is important to understand what debt to income ratio is. Basically, you just take your monthly payments toward debt (add up all of your debt payments including home, car, credit cards plus any other recurring payments) and divide the number by your total monthly income. This is an essential part of your budgeting. Your debt should not be more than 20%-40% of your income. You can see some example calculations here. That 20%-40% should be good debt. All other debt should be paid down as fast as possible.
Is it ok to carry a credit card?
For most people it is just fine to carry cards if you have a little bit of self control. Credit cards offer us convenience, an emergency fund, and in some cases even reward points. It helps to stay disciplined if you follow the the budget that has been created for you. You can find more information about deciding if credit is right for you on our guide to credit page.
Is there such a thing as a good debt?
Most people agree that there are types of good debt. For example, many people are burdened with student loans, but if it helps achieve their career goals and provides a well paying job, it is probably well worth the debt. A home or car may also be a good long term investment for an individual or a family. However, high interest credit cards should only be used as a last resort. It is important to budget for all expenses and have a plan for paying loans back before you take them out.
What is the difference between secured and unsecured debt?
Secured debt is something that is backed by an asset. Common examples of this include a home or a car. Unsecured debt is debt that is not secured by any asset. For example, when you purchase groceries with a credit card, there is not an asset that the bank can take from you if you do not pay your bill. Unsecured debts usually come in the form of credit cards or other unsecured bank loans. They usually carry with them extremely high interest rates. You can find more information about the topic by clicking here.
How much debt is too much?
There is no simple answer to this question. It will vary from person to person and from one situation to another. It is important to understand what debt to income ratio is. Basically, you just take your monthly payments toward debt (add up all of your debt payments including home, car, credit cards plus any other recurring payments) and divide the number by your total monthly income. This is an essential part of your budgeting. Your debt should not be more than 20%-40% of your income. You can see some example calculations here. That 20%-40% should be good debt. All other debt should be paid down as fast as possible.
Part 2 - Attacking the Debt:
If you find yourself in debt there is no need to panic. There are millions of Americans suffering the exact same problems as you. It is important to have a plan for getting out and sticking to it. Below are some simple steps to follow in order to get out of debt.
Step 1 - List your debts: Don't just keep them in your head, write them down. It will feel good to check them off when done.
Step 2 - Put them in order: Order them from smallest interest rate to largest interest rate. It makes mathematical sense to do it this way. You will try to pay them off 1 at a time, starting with the highest interest rate.
Step 3 - Attack the debt.: You are going to attack the debt at the top of your list with as much money as possible. Find ways to cut your budget to attack it with as much money as possible. All of your other debts you can just pay the minimum payment on. As stated before, it will feel good to scratch each debt off your list.
Step 1 - List your debts: Don't just keep them in your head, write them down. It will feel good to check them off when done.
Step 2 - Put them in order: Order them from smallest interest rate to largest interest rate. It makes mathematical sense to do it this way. You will try to pay them off 1 at a time, starting with the highest interest rate.
Step 3 - Attack the debt.: You are going to attack the debt at the top of your list with as much money as possible. Find ways to cut your budget to attack it with as much money as possible. All of your other debts you can just pay the minimum payment on. As stated before, it will feel good to scratch each debt off your list.
Part 3 - Now that You're Out...
Getting out of debt could quite possibly be one of the hardest things you have ever done. Congradulations! It's not over yet though. This is, however, a good time to re-assess your situation. You need to make a commitment to not fall back into the debt trap again. There are a few steps you need to take:
Step 1 - Build up an emergency fund: You should have an emergency fund that will cover any unexpected expenses that come up. This will help you from falling back into the debt trap if your car should break down, or your roof suddenly needs replacing. A good rule of thumb is to have about 3 to 6 months of your living expenses for your family. You can adjust this to your situation based on your job security, age of your home, and other personal factors that may require you to have more or less of an emergency fund. However, we recommend a minimum of 3 months expenses.
Step 2 - Visit your short term goals: All of the money you have been putting toward your debt and emergency fund can be put to other use now. This is a good place to reward yourself. Maybe you can use this money to buy a new car for your family, or new windows for your home. Be sure to include these items in your budget and do not fall back into the debt trap.
Step 3 - Looking Long Term: You can also take a look at your long term goals at this point. These are typically things that will not happen for at least 5 years or longer. If you have not yet began to put money away for retirement, this is a good time for that. You can also put money away for your childrens education, or the down payment for the home of your dreams. You could also use this extra money to begin to pay off your mortgage, if you have not yet done that.
Step 1 - Build up an emergency fund: You should have an emergency fund that will cover any unexpected expenses that come up. This will help you from falling back into the debt trap if your car should break down, or your roof suddenly needs replacing. A good rule of thumb is to have about 3 to 6 months of your living expenses for your family. You can adjust this to your situation based on your job security, age of your home, and other personal factors that may require you to have more or less of an emergency fund. However, we recommend a minimum of 3 months expenses.
Step 2 - Visit your short term goals: All of the money you have been putting toward your debt and emergency fund can be put to other use now. This is a good place to reward yourself. Maybe you can use this money to buy a new car for your family, or new windows for your home. Be sure to include these items in your budget and do not fall back into the debt trap.
Step 3 - Looking Long Term: You can also take a look at your long term goals at this point. These are typically things that will not happen for at least 5 years or longer. If you have not yet began to put money away for retirement, this is a good time for that. You can also put money away for your childrens education, or the down payment for the home of your dreams. You could also use this extra money to begin to pay off your mortgage, if you have not yet done that.
Checking for Understanding
The dealing with debt quiz can be found on the teacher resource page.
The assessment for this module will be for you to act as the financial advisor for a friend in need. Pretend your friend came to you with the following scenario:
"Your friend Max has always had trouble handling money. He just got out of college and has gotten his first well paying job. He has some money to help bring down his debt but he just doesn't know where to begin. He has the following debts:
- $15,000 in student loan debt
- $4,000 on a mastercard from Bank of America at an interest rate of 23.99%
- $3,500 on a Visa from his local credit union at an interest rate of 10.99%
You must create a response that is 3 paragraphs in length. The paragraphs should contain the following information:
- Paragraph One: Explain what types of debt he has (secured vs unsecured). Tell him what a debt to income ratio is and tell him whether or not his is reasonable.
- Paragraph Two: Outline a plan that will allow him to get out of debt the most practical way. Be sure to use the principles learned in this module.
- Paragraph Three: Give him a plan for moving foward once the debt is paid off that will allow him to remain debt free for the rest of his life
