All About Debt: Dangers and Strategies to Manage Debt
SaveThis article will discuss some of the dangers associated with debt before going into strategies to manage debt.
By Paul Merimee
In the last article, the various types of debts were explained before going into more depth about particular types of student loans. As a quick reminder, there is secured debt (backed by collateral), unsecured debt (backed by credit score), revolving debt (like credit card debt), and non-revolving debt (like a student loan). While debt can be used to obtain things like a college education or even a home, it does bring with it certain pitfalls that can prove disastrous if one is unaware and unprepared. This article will discuss some of the dangers associated with debt will be explored before going into strategies to manage debt once it has gotten out of control and is no longer beneficial but detrimental.
Dangers of Debt
High-Interest Rates
While this danger is legitimate, it may vary based on individual circumstances. The better the credit score, the more collateral one will correlate to lower interest rates. Students usually have low credit scores due to the limited length of credit lines and little collateral, so the high-interest loans available can make it difficult to pay off the debt promptly, particularly if too much is borrowed or payments are made missed. Put bluntly. If debt is allowed to accrue under high-interest rates, it can quickly lead to financial ruin.
Low Credit Score
Falling into debt can harm credit scores. A low credit score can make it difficult to get loans or credit cards in the future, limiting financial options, particularly if secured loans are unattainable. Students should focus on paying their bills on time and never spending more on their credit cards than they have in their bank.
Health Problems
A 2014 review by Turunen and Hiilamo found that indebtedness following the 2008 financial crisis caused increased depression, depressive symptoms, and suicidality. One of the studies reviewed also identified a possible positive feedback loop between indebtedness and poorer physical health, though they could not provide a causal explanation. Regardless, the negative effects of indebtedness are abundant and should be considered before taking on debt.
Limited Financial Options
Once locked into debt, financial options can quickly dry up due to the obligation to repay said debt. Saving for the future, investing in stocks, or making other positive financial decisions may be entirely off the table due to the weight of the debt. Students may struggle to get credit cards or qualify for private student loans to cover their education if they have too much debt (and, consequently, low credit scores). Thankfully, there are ways to minimize these dangers.
Managing Debt
Make a Budget
While this advice is simple, it is at the base of all the other strategies. In order to properly manage debt, the total financial picture needs to be considered so that appropriate strategies might be applied. Depending on one's financial situation, how the debt is handled may look different.
Debt Avalanche
If there are multiple types of debt at play, the highest-interest debt should be taken care of first. This method should save the most interest payments and reduce the overall amount owed. It is, however, difficult to implement as it takes a strict budget and discipline to put discretionary funds into the debt, which limits the amount available to spend on things like clothes, food, or social events. The lack of discretionary funds can also put the borrower at risk should an emergency expense occur.
Debt Snowball
If there are multiple types of debt at play, the smallest debt should be taken care of first. This method is more expensive in the long run than the debt avalanche method; however, it is far easier to manage and can be psychologically beneficial to the borrower as they are more quickly eliminating individual debts. The debt snowball and avalanche methods can be combined, where a middling debt with a high-interest rate is tackled first. The amount of debt and the debt diversity may determine which method is most appropriate.
Make Payments
If the prospect of dealing with interest rates is daunting, the simplest way to deal with debt, particularly credit card debt, is to pay on time. Avoiding interest accrual is especially essential for students, who often don't have full or even part-time incomes to pay off mounting debt. If a student can qualify for a direct, subsidized loan, then avoiding interest will be easier as it does not accrue while in college. However, subsidized loans have lower limits, and many students will not qualify, so for them it will be crucial to manage interest through consistent payments.
Avoid New Debt
This is perhaps obvious, but like budgeting, it is essential. It will be increasingly difficult to pay off current debt if new debt is constantly being added, so until the current debt is gone, it is best to avoid accruing any new debt if possible.
Debt Consolidation
As a caveat to the above tip, if there are multiple debts with varying interest rates, it may be beneficial to consolidate all the debts under a single loan like a home equity loan, balance transfer card, or debt consolidation loan. Whether this is beneficial or not should be discussed with a financial advisor as it tends to be a complicated calculation and depends on various factors. Furthermore, most students will not need to consolidate debt as they have not had enough time or resources to collect the diversity of debt required for consolidation. However, students need to be aware of this strategy as they may need it post-graduation.
Seek Help
Finally, if the stress of dealing with debt is too much or simply confusing, it would be wise to seek the help of a financial advisor or credit counseling service. Consumer Credit Counseling Service (CCCS) | Credit.org is a good starting resource.
Debt is a common and often unavoidable part of life, so it's important to understand the different types of debt, the dangers of falling into debt, and strategies for managing debt. With the proper knowledge and experience, debt can be leveraged for good outcomes. Students are well-positioned to do this through learning about debt, building solid financial habits, and securing a strong financial future.
Paul Merimee
Paul Merimee grew up in sunny and vibrant Cleveland, Ohio with his eight siblings. In his early years Paul loved to read, voraciously consuming anything that had an engaging front cover at the library. Paul wanted to be a software engineer, not an author. He somehow ended up going to a small, liberal arts college in the middle of Wyoming. It was there that he was introduced to the great writers like Homer, Dostoevsky, Aristotle, and more.Articles & Advice
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