How to take control of your debt to achieve your goals.
The rise in interest rates has presented an extra challenge for individuals aiming to effectively manage their debt obligations. When rates go up, the cost of new and existing variable rate credit cards and loans also rises. Higher minimum monthly payments on those debts potentially divert funds that could otherwise go toward achieving short- and long-term financial goals.
However, an effective financial strategy makes it possible to reduce debt and achieve your goals even in the current economic climate.
Assess your debt landscape.
Pull together all of your debt, including student loans, car loans, bank credit cards and store credit cards. Write down the balance, interest rate and monthly payment for each. “It’s also a good idea to review recurring bills like cable, cell phone, gym memberships and utility bills,” according to Bill Gandolfo, product manager of consumer lending, Commerce Bank. This gives you a solid grasp of what you owe, which account has the highest interest rate, and the total debt payments you need to budget for each month to avoid added charges.
Clarify your financial goals.
What are you hoping to do, and by when? List your financial goals, from paying off your debt to buying a house. Be sure to make them S.M.A.R.T.
Set financial priorities.
Depending on your situation and timeline, you may need to focus on one goal more than the others. We recommend making your emergency savings account your next priority, followed by saving for the long-term goals you listed. “You should have at least three to six months of living expenses saved before moving on to your long-term savings goals,” says Gandolfo.
You may need to adjust your timeline depending on your priorities and what you can realistically afford. Commit to paying a certain amount toward your goals each month — whether that’s credit card payments or deposits to your savings account.
Secure lower rates.
Look into options for lowering your interest rates to free up more cash flow. You can consolidate debt into a personal loan, which lets you focus on a single monthly payment and may reduce the interest you pay in the long run. You may be able to lower your interest rate even more by setting up automatic loan payments from your checking or savings account.
With a balance transfer, you can move your balance to a credit card that offers a lower interest rate for 12 months on purchases and balance transfers. Use that time in the promotional period to get the balance paid off, and start focusing on other debts.
Choose a debt reduction method.
Use the “snowball approach” to pay down debt faster.
Select your debt with the smallest balance as your first target for elimination and follow these steps:
- Make at least the minimum monthly payments on your accounts, but pay as much as you can afford each month on your target debt. You’ll pay off the balance faster by making a larger monthly payment.
- Once that’s paid off, identify the debt with the next-smallest balance.
- Combine the money you were paying on the first debt with the amount you’ve been paying on the second target debt, and apply that toward the balance.
- Repeat the process for each debt.
The snowball approach provides quick wins that can motivate you to stick with the repayment strategy. However, it can take longer to eliminate debt as higher balance debt.
Use the “avalanche approach” to save the most interest.
Select your debt with the highest interest rate as your first target for elimination and follow these steps:
- Make at least the minimum monthly payments on all of your accounts, but pay as much as you can afford each month on your target debt. You’ll pay off balances faster by making larger monthly payments.
- Once that’s paid off, identify the debt with the next-highest interest rate.
- Combine the money you were paying on the first debt with the amount you’ve been paying on the second target debt, and apply that toward the balance.
- Repeat the process for each debt.
The avalanche approach lets you get out of debt faster than the snowball method. However, it could take longer to eliminate debt if you have multiple high rate accounts with large balances.
Spend with purpose.
The key to meeting your goals is making the payments and savings deposits you’ve committed to each month. To do that, you’ll need to keep track of your spending.
Review your monthly expenses and look for areas you can trim — like the gym membership you rarely use, eating out one time less per week, or switching to a less expensive cable or mobile phone provider. Also consider putting any extra income, like bonuses or tax refunds, toward your target debt and goals.
It can be hard to know where to start, but clarifying your situation, goals and priorities provides valuable perspective for tackling your debt. Explore free financial tools like Commerce Bank CONNECT® and Online Banking to simplify money management.
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