Your Guide to Achieving Zero Consumer Debt—and Keeping It That Way
Does the thought of your student loan principal balance keep you up at night? Are you paying the monthly minimum on your credit cards and slowly accruing more and more debt?
Getting out of debt can feel like an impossible task when you’re in the thick of it. But when you’re empowered with financial knowledge and equipped with strategies to tackle it, it can become a little more manageable. Start with this guide to consumer debt to get your finances under control (and sleep a little easier!).
Breaking It Down: The Basics
Everyone has to start somewhere, and when it comes to debt it’s important to understand the basics first. So here’s a quick rundown of the types of debt you might be juggling.
There are four main categories of debt: secured, unsecured, revolving, and mortgages.
- Secured debt is collateralized by a good. A great example of secured debt is a car loan. The car is the good that can be taken away if you do not pay off the secured debt.
- Unsecured debt is not held by collateral and is often thought of in the form of credit. For example, nothing specific can be taken away as collateral if you are late on making a payment to your credit card. Two other examples of unsecured debt include medical bills and some student loans.
- Revolving debt is a recurring loan that is agreed upon by a lender and a consumer. Credit card debt is both unsecured and revolving, because each month you can charge up to a certain amount, build up debt, pay it off, and then start the cycle again.
- Mortgage debt is when you take out loans to continually pay off your home. This is also a form of secured debt, as the home itself acts as collateral and can be taken away if payments are not made.
The Lowdown on Loan Interest Rates and Principal Payments
Another important aspect of managing your debt is understanding how debt accrues through interest rates and principal payments.
Your loan principal is the amount of money borrowed that needs to be paid back. For example, if you get a car loan for $3,000, then that is your initial principal. You will typically make monthly payments toward that initial principal (i.e. principal payments) plus interest.
In terms of the interest, the interest rate is essentially a periodic or monthly charge that must be paid for the service of borrowing money from a lender. Interest rates can vary in percentage typically depending on your credit rating and the risk of the loan.
Interest rates can be fixed or variable. Fixed rates, which stay the same until the loan is paid off, are more common. By contrast, variable rates depend on a number of factors including but not limited to the going prime rate for loans. When you take on debt, make sure you’re reading the fine print to fully understand what your monthly payments will look like.
Three Simple Steps to Pay Down Your Debt
Once you’ve taken stock of your current debt, it’s time to make a plan to tackle it. We’ve boiled it down into three simple steps that will set you on the right track.
- Consider ways to lower your overall interest rate.
- Prioritize which debt to tackle first.
There are two popular strategies for paying off debt: you can start with the loan that carries the highest interest rate, or knock out the loan with the smallest remaining balance first.
If you choose the first route, you should pay the minimum on your accounts each month and put all the extra money you can towards the loan with the highest interest rate. Once you’ve paid it off in full, move on to the loan with the second-highest rate.
If you opt to pay off your smallest balances first, the general philosophy is similar: pay your minimums, then put all the extra cash you can towards your lowest balance until you pay it off. Knock ‘em out one by one until all of your debts are paid.
- Slow and steady wins the race.
Takeaways for the Long Haul
Now that you have a firm grasp on the basics and a solid plan for conquering your debt, it’s important to lay a foundation for healthy financial habits in the long term. Here are a few strategies to do just that:
- Create an emergency fund.
- Keep your future financial goals in mind.
- Keep tabs on your day-to-day expenses.
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Zip’s editorial content is not written by a financial advisor. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.