U.S. households collectively owed more than $17 trillion in the first quarter of 2023, in the form of mortgages, student loans, auto loans, credit cards, and more. While some types of loans, such as home loans, are considered "good debt", owing large amounts of money can cause stress and anxiety and prevent you from building wealth.
No matter what type of debt you currently have, or how much money you owe in total, paying down your balances can be beneficial in many ways. Here’s what debt repayment can do for you:
- Improve your credit score. Your credit score acts as a summary of your creditworthiness. A low credit score can make it hard for you to qualify for additional financing or prevent you from receiving favorable loan terms and rates. Without financing it can be difficult or impossible to purchase big ticket items such as a home or vehicle. While many things factor into your credit score – including how long you’ve had existing loans or credit cards and whether or not you’ve missed any payments – the amount of debt you currently owe plays a big role as well. The percentage of your available credit that you’re currently using is called your credit utilization ratio. As you pay down debt you’ll reduce your credit utilization, which can help improve your credit score.
- Make money management easier. Debt can complicate your life, especially if you struggle to pay multiple bills each month. Juggling a large volume of bills increases your risk of making late payments or missing payments altogether. Paying off some of your loans and credit cards will result in less paperwork and can make it easier for you to budget and stay organized.
- Save money on interest fees. Credit cards in particular can take a huge bite out of your wallet in the form of interest charges. Many credit cards have interest rates of 18% or more. The longer you carry a balance on a credit card, the more you’ll end up paying in interest. In fact, the compounding interest on credit cards makes them exceptionally difficult for many borrowers to pay off. Paying off your credit card balances can save you serious money in the long run. In most cases you can save significant funds by paying off your car loan or mortgage early as well. Just be sure to check the fine print on your loan agreement to be sure you won’t face a pre-payment penalty.
- Build your wealth. The less money you’re paying in interest fees, the more money you’ll have to put towards your savings goals such as retirement, college tuition, a down payment, or a dream vacation. Whatever your financial objectives, reducing your overall debt can go a long way toward helping you achieve them.
Tips to Repay Debt
Paying off debt can seem impossible, but there are some tried-and-true ways to start the process and help you on your way to a better financial future:
- Consolidate debt. Use a debt consolidation loan or debt repayment plan to combine multiple debts into one monthly payment. This strategy can potentially lower your interest rate and can speed up your repayment timeframe. Plus, having fewer monthly bills can help you avoid missed or late payments.
- Pay off high-interest debts first. One strategy is to list your debts in order of their interest rates. Then, you can focus on repaying those that are costing you the most in interest. Once you’ve identified which loan or credit card to tackle first, you can use a payoff calculator to help formulate a plan of action.
- Prioritize debt repayment in your budget. You should analyze all of your ongoing expenses to determine where you may be able to make some budget cuts in order to free up more money for debt repayment. You’d be surprised how much money you can save by shopping for better insurance rates, canceling unused and unwanted subscriptions, making home energy improvements, or making your daily coffee at home.
- Focus on financial goals. One way to stay on track with your debt repayment efforts is to outline your specific savings goals. Whether you have goals for retirement, education, home ownership, or something else, keeping them top of mind can give you the motivation you need to pay down your debt as quickly as possible.
- Readjust your attitude toward money. As you pay off your debt, you should make a commitment to avoid piling up debt in the future. Start by evaluating your needs versus wants. Then, address spending triggers like boredom that push you to waste money. Get in the habit of thinking through each purchase before you make it.
Debt can be essential to reaching your financial goals – if you use it correctly. A loan can allow you to purchase a home or car, and a credit card can help you build credit or earn cash back. The trick is to manage debt responsibly and pay it back in a way that will minimize interest fees and any potential damage to your credit score.