The reason the topic of debt is important in estate planning is that any long-term persistent debt problem can ‘derail’ even the best structured estate plan.
This article gives a brief overview of the different types of debt and hints about paying down debt.
Secured debt is one in which there is collateral. Examples of this are the mortgage on a house and a loan on a car. In simple terms, the house and car are the collateral for the debt. If you do not pay the debt, the consequences are that you ‘lose’ the collateral – foreclosure of house or repossession of car.
Unsecured debt is debt where there is no collateral. Examples of this are credit card debt or a student loan. Interest rates on unsecured debt may be higher than secured debt.
(Remember that co-signing on a loan is the risk of acquiring an unsecured debt from someone else.)
Debt to income is a ratio of your recurring debt divided by your gross monthly income (although there may be other formulas used.) An example: your recurring debt is $1,000 per month and your gross monthly income is $5,000 – the ratio is $1,000 divided by $5,000 or one- fifth (20%). A rule of thumb is to keep your debt to income ratio below 20%.
Types of debt
Mortgage
Auto Loan
Student Loan
Credit Card
Medical
Co-signing on Loans (puts you into risk of acquiring debt)
Average debt can vary by age group. According to some statistics, those in the 45 - 54 age range have the most average debt. Those over 55 have the most medical debt.
Plans to Pay Off Debt
There are two schools of thought when it comes to strategies to pay off long- term debt.
1) Pay off the smallest debt first. Then use those funds to pay off the next smallest debt, etc. This gives the satisfaction of seeing some debt ‘disappear’ over time. However, the smallest debt may not be the one with the highest interest rate.
2) Pay off the recurring debt that has the highest interest rate first, regardless of the total amount of the debt. This may not be the most ‘satisfying’ method, but makes the most economic sense. Example: A credit card with very high interest rate would be the first debt to pay off.
Ways to ‘Bust’ Debt
Slim your services – for example cable, telephone and expensive internet plans
Negotiate – for an expensive item or service, try to negotiate a better “deal”. Talk to service providers and credit card companies to seek better rates.
Seek out free stuff for entertainment – for example free local entertainment events
Enjoy ‘Staycations’ – rather than going into debt for expensive vacations. Hint-some hotels will rent a pool cabana/daybed for the day to non-guests. You can enjoy the luxury of a top-class hotel with just the cost of a rented pool cabana.
Need versus Want – analyze purchases to decide whether a new item is truly ‘needed’ versus just a passing desire. Often re-purposing an item can give as much satisfaction as buying new.
Make a budget – and stick to it
Eat home more often – dining out is fun, but frequent outings can put a dent in a family budget. Use the dining out experience as a ‘treat’ when you have achieved a goal in reducing your debt.
Lastly – Do not ignore debt. It will not go away by itself.
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