5 Steps to Eliminate Bad Debt

By Mikaela Parrick

U.S. household debt grew by $63 billion, or 0.5%, to $13.21 trillion in the first quarter of 2018, driven largely by the increase in mortgage balances, according to a recent report by the New York Federal Reserve.

The report stated that balances rose 0.6% on mortgages, 0.7% on auto loans and 2.1% on student loans this past quarter, while they declined by 2.3% on credit cards.

The amount of mortgage balances rose by $57 billion in the first three months of 2018 to $8.94 trillion.

Families, however, paid down their home equity loans, which fell by $8 billion to $436 billion, according to the report.

What is the difference between good debt and bad debt?

Bad debt is debt that doesn’t increase your net worth, has no future value and that you don’t have money to pay for.

Examples of bad debt include credit cards, auto loans and store credit cards.

On the other hand, good debt is considered an investment that generates long-term income or value.

How much bad debt is too much?

You can figure out if you’re living within your means by calculating your debt-to-income ratio.

To find this, add up all your monthly debt payments and divide that by your monthly gross income.

Anything over a 43% debt-to-income ratio is a red flag to potential lenders and shows that you are living beyond your means.

How do I get rid of bad debt?

Getting rid of bad debt takes time and commitment.

Here are some steps you can take to reduce your bad debt:

1. Prioritize your bills

Prioritize your bills by paying off secured debts first, like auto loans and mortgages.

Then pay off unsecured debts like student loans, child support and taxes.

Next, pay off unsecured debts that are likely to appear on your credit report, and finally, unsecured debts that are least likely to go into collections.

However, remember that while some agencies don’t bother with smaller amounts, others specialize in collecting smaller amounts of debt.

There’s no way to tell if a debt will go into collections or not, so it’s best to just pay what you owe.

Another good thing to do to make sure you don’t miss any payments is to set up automatic payments through your bank or through the creditor.

This way, all your payments are scheduled in advance and there’s no worry about missing a payment and causing further damage to your credit score.

2. Create a budget

Creating a budget not only let you know where your money is going, but it can also help you curb any unnecessary expenses.

A great rule of thumb for budgeting is the 50/30/20 rule.

The 50/30/20 rule was first coined by Harvard bankruptcy expert Elizabeth Warren as a way to spend and save money.

The idea is to spend 50% on your needs, 30% on your wants and put 20% into your savings account or toward debt repayment.

3. Make more, spend less

See if you can increase your income to cover your debt.

Consider putting in more hours at work or getting a part-time job.

4. Don’t ignore collection calls

Ignoring collection calls won’t make the debt go away and could make the situation worse by further damaging your credit score.

It’s best to acknowledge the debt and explain why you can’t pay it.

The collector or the credit card company may be able to help you out by with the interest rate and payment due dates.

You could also get on a repayment plan.

5. Educate yourself

There are many resources and programs that can help if you look for them, like repayment plans or loan modification plans.

You should also be educated on the more serious options for debt repayment, like consolidation and bankruptcy.

Always read the fine print and understand your responsibilities as a borrower/debtor and what the consequences are for failing to repay what you owe.

Additionally, be sure you understand the components used to determine your credit score and how it is impacted.

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