If your finances are a little out of control, there is a lot you can do to bring stability back. Paying off your debt is an important part of tidying up your financial life.
While it may seem overwhelming at first, explore and take it step by step. There are many resources, such as the best personal finance blogs, that can help you get started.
Debt can undermine your finances and create a feeling of heaviness on your shoulders that never seems to go away. Debt not only stops you from saving for the future, it also gets in the way of living with the freedom you deserve.
Think about what you could achieve if you did not have the obligation to pay off your salary every month to pay off debt. You would have the financial freedom to pay yourself first and live the way you want. This could include giving up paycheck to paycheck, saving for retirement, funding a family vacation, working your favorite job, or just not worrying about how much money is in your bank account.
Now, you might think that paying off a debt is as easy as putting as much cash as possible in your loans, and you will be partly right. However, there are many other factors that affect debt repayment that you may not have considered or even knew.
With that in mind, here are six facts you didn’t know about paying off debt.
6 facts you didn’t know about paying off debt
1. Paying off your debt will help you retire early
Your income is the most valuable wealth creation tool you have. When you work to pay off debt, you are allowing your income to be used more efficiently.
You can invest your income in savings rather than use it to pay bills. This is very effective if you want to retire early, and even more so if you start saving sooner rather than later. This gives the power of compound interest the ability to work miracles over time.
When planning for financial independence (FI) and early retirement, you need to calculate the savings rate, the number of FI, and the number of years before FI. It’s easy to do with the FIRE calculator, but your work doesn’t end there.
You need to assess your current financial situation, make a plan and execute it. When it comes to taking control of your finances, in most situations, the first step to making progress is paying off your debt. Paying off your debt can be the first step to achieving FIRE.
2. You will create flexibility at work
How often do you hear people say, “I hate my job?” Money is usually the driving force when it comes to staying in jobs that you hate and away from jobs that you might love. In other cases, it gets in the way of pursuing a passion, doing business, or staying at home as a parent.
Paying off debt is a great way to free up money in your budget to provide more flexibility when it comes to trading your time for money. This is because you will have fewer monetary obligations to fulfill each month.
Reducing the number of bills you pay each month can give you the wiggle room you need to make a financially secure transition. Whether you want to work alone or not work at all, taking debt off your shoulders can open many doors for you and your family.
Life without debt is great, isn’t it?
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3. Your credit score may decrease or disappear
You may panic and ask, “Why did my credit rating drop after paying off the debt?” He should help you, not harm you. Unfortunately, this may not be the case in the short term.
The two main factors that can affect your credit rating when paying off debt are:
- Use of credit – measures your credit balance against the number of lending institutions that lenders say you can have. This can be affected if you are paying off debt from an account with a low balance, but the rest of your cards are depleted.
- Credit mix – refers to the type of debt you have. In other words, a good credit rating will have a range of debts: mortgages, car loans, credit cards, and others. When you pay off one type of debt, especially if it was in a set repayment cycle, it can negatively impact your credit.
Don’t worry, the amount of good you do for yourself far exceeds the amount the credit bureaus call you. It is very likely that it will bounce back over time, so you will have a good credit rating in the long run.
Paying off your debt is an important part of improving your financial life, so don’t let a downgrade in your credit rating hold you back or stop you. Keep going! To cushion any shocks to your credit score, keep making payments on time and balance your utilization rate. You may also want to consider paying off debt with high interest rates first, such as personal loans or credit cards.
If you pay off all your debt, it may disappear altogether. However, the problems with this refer to another post.
4. More money will appear in your budget
So, you may already know how to budget for debt, but have you ever considered budgeting without debt? You may be so excited about paying off your debt that you haven’t had time to think about the opportunities that await you.
The money that you have been saving all this time to pay off the debt can now be placed elsewhere. While it may sound tempting, don’t fall for the silly lifestyle! This is not your chance to improve your home or car, or reinforce any other spending habits. Use this instead as a great opportunity to invest in yourself by making smart financial choices.
Here are some great examples of what you can do with the extra money burning a hole in your pocket:
- Create a reserve fund
- Start or increase your retirement contributions (IRAs and 401ks are a great place to start).
- Save on College at 529
- Make a vacation repayment fund (use travel rewards to keep your expenses down)
- Invest in real estate, actively or through a company like DiversyFund.
- Start a business
Using money wisely can help you accumulate wealth over time for yourself and your family.
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5. Debt strategies affect your overall costs
If you’ve heard of Dave Ramsey, you’re probably familiar with the snowball and debt avalanche methods of paying off debt. While he believes the debt snowball method is the only way to pay off debt as it increases motivation, I’m here to tell you to think again.
Paying off the debt, you need to act correctly. This includes thinking about how your debt repayment strategy will affect the total cost of debt. A financially savvy way to pay off debt is the debt avalanche method.
If you still don’t know how to apply this method to your finances, follow these steps:
- Write down all your debts (car loans, student loans, credit card debt, etc.)
- Place them in order, starting with the highest interest rate to the lowest interest rate.
- Pay off your debts in this order.
The idea here is that you save money on interest by paying off the debt at the highest interest rate first, then moving on to the next highest, and so on. You can potentially save thousands by implementing this strategy alone. If you’re just starting out on your debt repayment journey, you probably didn’t know it.
Dave Ramsey believes that starting with the smallest debt number and progressing until you reach the highest amount of debt is the right path (aka the debt snowball method). However, anyone who understands simple math understands that it will cost you a lot of time.
6. Debt sells for pennies for a dollar
Did you know that some debt is sold for pennies for a dollar?
Allowing debt buyers to buy out debt is one of the ways companies try to get back the money they loaned you. So be sure to check everyone who contacts you about existing debts, but don’t be surprised if your debt now belongs to someone else. This is especially true for those with credit card debt.
These debt buyers are more prone to high-risk investments, so they buy your debt for a fraction of your debt. If you pay off a debt of $ 10,000, for which they only paid $ 1,000, they will receive an incredibly high income.
While this may seem like an incredibly limited business, some good things have come out of it. Companies like RIP Medical Debt accept donations for use for the same purpose. Differences? They buy medical debts for pennies on the dollar, but turn around and forgive them.
Can you imagine the relief that individuals and families experience from this? At the time of this posting, the company has helped pay off over $ 1 billion in debt!
Debt settlement work in 2020
As you can see, there are many benefits to paying off debt, from something as incomprehensible as financial freedom to something as simple as increasing the amount of money in your bank account. However, it is important to consider other factors that will affect your debt-free travel.
Overall, keep making smart money transfers in 2020 while paying off your debt. You will thank yourself later when you discover the opportunity to shape your own life.
This article originally appeared on The Money Mix and has been republished with permission.