This post originally appeared on The Financially Independent Millennial.
Is your credit card debt behaving like an unruly boy and has gone completely out of your control? Are you spending sleepless nights wondering how to get yourself out of a debt spiral? Or perhaps it's a burgeoning credit card debt?
Worrying about your credit card debt without taking any concrete action won't help to tame your spiraling, out-of-control debt. You have to understand why your debt has spiraled out of your control and then use a few tips to tame it. We will discuss these things in this article. So, let's get straight to the topic.
Why Your Debt Has Spiraled out of Your Control
A physician cannot prescribe medicine without understanding the reason behind your illness. Likewise, you can't control your debts without understanding why they are beyond your control. A few possible reasons behind your burgeoning debt are as follows:
Spending more than what you earn.
Buying things or subscribing to services that you can't afford.
Having a bad habit of using credit cards to buy what you can't afford.
Not paying credit card bills on time.
You have a habit of exhausting your credit limit quickly
Whenever you are short of cash, you tend to take out a high-interest loan.
You got married or had a sudden medical emergency for which your debt went out of your control.
How to Control Your Debt Yourself
Once you've understood where the problem is, you can start looking for options to reduce credit card debt. Here are some options that you can explore.
Look Where You Are
What kind of debts do you have? How many credit cards and unsecured loans do you have? What is your total debt amount? How much do you need to pay every month? Can you afford the monthly payments? What is the current APR (Annual percentage rate) on your credit cards? If none of this looks any good, you could be in a debt spiral without even knowing it!
You need to get the answers to these questions. Where can you get all the answers? First, look at your credit report. All the answers are there. Next, you have to check your bank and financial statements to get an idea of your net worth. Calculate the total value of your assets. The best way to calculate your net worth is by subtracting the total value of your liabilities from your assets.
If you're a fresh grad, then your net worth is likely low. And, if you have both student loans, and credit card debt, it may feel like a debt spiral. But, there's nothing to worry about. There are lots of ways to increase your net worth. And as far as your debts are concerned, there are ways to reduce or pay them off with a well-conceived strategy. The key is starting NOW, and not waiting.
Make a Budget
You need money to get a grip on your debt spiral. How will you get the required money? The first option is to ask your boss for a pay hike or a promotion. But, that's up to your boss's discretion. The second option is to get a side hustle so that you can increase your monthly income. But, side hustles take work. The third option is learning how to make a budget and generate free cash. This is in your hand.
Look at your credit card statements and bank statements to know how much you have spent money and where. Make a list of the items where you have spent money. If it looks like your list is never-ending, you are probably in a debt spiral and need to get out of it. Next, make a list of the necessary and unnecessary expenses. Make sure you do an honest review of your expenses. A biased review won't be of any help.
Focus on Needs
Once you get a list of unnecessary expenses, your job will be to figure out what to cut out. Your focus should be on necessary expenses like food, utilities, insurance premiums, mortgage, utility bills, etc. Find out ways to save money on the necessary expenses also so that you can generate a significant amount of free cash. You could lead a frugal life so that you can discover new areas where you can potentially save money. Having a monthly surplus can be key in learning how to get out of a debt spiral.
The Snowball Method: A Debt Spiral Killer
The debt snowball method shows you how to pay off debts gradually. With the debt snowball method, you make minimum payments on all your debts every month. But that won't help you to get out of debt quickly. Right? In this method, you make additional payments on the account with the smallest balance every month until it's paid off. You can use the money saved by budgeting to make extra payments on your debt.
Once you have paid off the smallest account, you can roll over the amount to the next one. That means the account with the second smallest debt, thus breaking the spiral. Keep on making additional payments on the second smallest debt until it's paid off. After, you can focus on the account with the third-smallest amount.
In the debt snowball method, you pay off accounts from the smallest debt amount to the highest debt amount, regardless of the interest rate.
Embrace the Debt Avalanche Method
If the snowball method isn't right for you, the avalanche method provides a mathematical approach.
The debt avalanche method is almost the opposite of the debt snowball method. Here, you pay off debts in the descending order of the interest rate. This means you start paying off debts from the highest interest rate to the lowest interest rate. Just like the debt snowball method, you make minimum payments on all your debts.
But here, you make additional payments on the debt with the highest interest rate. And, you have to make additional payments on the highest-interest rate debt until the balance becomes nil. Then, you have to roll over the amount (the minimum payment amount and the additional amount you paid every month) to the second-highest interest rate debt. And, you have to keep on doing it until the second-highest debt is also paid off.
Follow the process with the remaining debts until you become debt-free.
Use the Debt Snowflake Method
Tiny savings can help downsize your debts. Even if you can save $10 every day, then your daily savings can snowball to $300 at the end of the month. You can use that money to make extra payments on your debts. The concept of the debt snowflake method is simple. You make tiny extra payments on the debts with your savings like snowflakes and work towards zero debt.
Debt snowflake is a debt elimination method where small savings collected over time and extra income can make a big impact on your debt repayments. But you have to use the accumulated savings fast to pay off debts at the right time. Otherwise, snowflakes will disappear.
How to Control Your Debts with Professional Help
There are many ways to control your debt spiral. You could budge,use the debt snowball method, debt avalanche method, debt snowflake method, etc. Or, you could get professional help for clearing your debts. Here's how you can get professional assistance for repaying your debts.
Control Your debt spiral with credit counseling
When you can't control your debt spiral on your own, you should contact credit counseling agencies first. They help cash-strapped credit cardholders to eradicate debts and establish a stable financial life. Credit counselors are certified financial experts who can help you to create a budget, understand and apply different money management techniques to generate free cash after analyzing your current financial situation. They can create a budget as per your financial situation and then offer you the best strategies to repay your debts. If you can follow their guidelines, then debts will be under your control soon.
However, if you can't control your debts even after following their instructions, then you can enroll in a debt management plan. Credit counseling agencies offer this plan in exchange for a fee. In this plan, credit counseling agencies negotiate with your creditors for arranging a customized and budget-friendly repayment plan for you.
Credit counselors are working in the debt industry. So, they can figure out ways to help you. You can be rest assured that they will work with you closely to get a good repayment plan for you at a low-interest rate–thus starting the process to get you out of the debt spiral.
The counseling session is often free, but you have to pay a fee for the debt management plan.
Key Features of a Debt Management Plan
A customized budget plan
Subsidized interest rates
An affordable payoff plan
No late fees and penalties
Opt for Debt Settlement
Debt settlement is a popular debt relief method. In a debt settlement program, you can get out of your debt spiral with a lower payoff amount. The debt settlement companies negotiate with your creditors for a lower payoff amount in exchange for a lump sum payment.
Suppose your debts total $60,000. But, you're in financial hardship and can't even make the minimum payments. In this situation, you can enroll in a debt settlement program. First, the debt negotiators will ask you how much you can pay in total. Based on your quote, they'll negotiate with your creditors. For example, they will tell your creditors that you can pay only $30,000 and that too, without any late fees and other charges. You're in a debt spiral due to pay cuts or loss of hours. As such, you can't pay the entire amount.
Debt settlement companies know the credit card laws, debt collection laws, the state, and federal laws. Also, they understand the psychology of creditors. And, they know the maximum amount that creditors can agree to forgive. Indeed, they'll negotiate with creditors accordingly. Last, they'll continue the negotiation process until creditors agree to forgive a portion of the debt amount.
Once creditors make the final debt settlement offer, the debt negotiators will ask you to make a lump sum payment on the date mentioned in the agreement letter. So, you make the payment, and your debts will be considered settled and paid off.
Key Features of the Debt Settlement Plan
An affordable payoff amount
No additional interests and fees
Opt for Debt Consolidation
Debt consolidation is another popular method to get out of a debt spiral. This debt relief method is as popular as settlement and helps to chip away debt over time.
There are three types of debt consolidation. The first one is a debt consolidation program. The second one is the debt consolidation loan. And, the third one is the balance transfer method. To be sure, these three methods help to control debt in different ways. But the basic function, to get you out of a debt spiral, is the same. The three types of debt consolidation help to lower interest rates and save money. Let's look at the basic details one by one.
Debt Consolidation Program
It's a debt relief program wherein your multiple debts are clubbed into a single monthly payment plan. A debt consolidation company negotiates with your creditors to lower your interest rates and arrange a repayment schedule, which you can afford. So, after a few negotiation sessions, when creditors agree to a repayment plan, you can start making a single monthly payment to the debt consolidation company. They will divide the amount and disburse it amongst your creditors.
Usually, the debt repayment plan lasts between 2 and 5 years. You have to stick to the repayment schedule for the entire plan. Plus, you have to pay a fee for enjoying the debt consolidation services. However, in exchange, you get out of the debt spiral.
Debt Consolidation Loan
This is a big loan that you take out to repay your multiple bills at once. Here you apply for a debt consolidation loan, and once lenders give the money, you can use it to pay all your unsecured debts. The interest rate of a consolidation loan is lower than credit cards and other unsecured debts. So, you save money on the interest, and you start to get out of the debt spiral.
Types of Debt Consolidation Loans
Home equity loan
Credit card debt consolidation loan
Payday debt consolidation loan
Student loan consolidation loan
Balance Transfer Method
A balance transfer can also be a type of debt consolidation where you replace your multiple debts with a single 0% or low APR credit card. Here, you pay off your multiple debts with a balance transfer card. Look for a balance transfer credit card with a 0% introductory APR for at least the first six months.
What Does It Mean for You?
A balance transfer generally has to be paid, in full, before the deferment period ends. But what if you can't pay the entire balance within that period? Well, in that case, you have to pay the standard interest rate on the outstanding balance, and that could be upwards of 20-25%. Of course, if you had another balance transfer offer elsewhere, you could repeat the process by balance transferring to another card, on another offer. But, sticking at 20% interest will certainly hurt your finances. So, you have to make a plan and pay the total amount within the introductory period.
Potential Risks You Should Be Aware of
Your credit score may drop in case of settlement as you are not paying the full amount. However, if your credit score is already low, then the negative effect will be less.
You may get scammed if you don't work with a genuine debt relief company. They may take money from you without helping you to control your debts.
If you opt for a long-term debt consolidation loan, then you'll pay less every month. That's for sure. However, you have to pay a huge amount in the long run. You may end up paying double the amount to lenders.
Related read: How to Improve Your Credit Score
Debt Spiral Words of Wisdom
Never pay an advance fee to a debt relief company. The FTC prohibits debt relief companies from charging advance fees. If they charge advance fees, then they're basically violating the law. Stay away from them when trying to get out of your debt spiral.
If nothing works in your favor, you can file bankruptcy to tame your debt. This is the final weapon you have to get out of your debt spiral.
There are two ways to eliminate your credit card debts through bankruptcy. First, you can file for liquidation bankruptcy and get rid of your debts within three to four months. The bankruptcy trustee will sell your non-exempt assets (if you have any) and pay back your creditors.
The other way is to file reorganization bankruptcy and pay off your debts strategically within 60 months. You have to propose a repayment plan to the court, and if they approve it, you can pay back your creditors gradually. It is a long time, and you need to have patience also. Plus, you cannot enjoy a single extra penny in these 5 years. If you receive a windfall, you have to use it for debt repayment. You cannot use it for other purposes.
What Should You Do Once Your Debt Spiral Is under Control?
Vow that you won't get into another debt spiral in the future. You'll value your money, use credit cards wisely, stay within your credit limit. Also, try to follow a good household budget, live frugally, save money, build your emergency fund, pay your credit card bills on time, etc. And, you have to take steps to rebuild your credit and financial life. Sure, it'll take time, but if you manage money efficiently, then everything should get on the right track eventually.