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Understanding Debt – How to Pay for the Past 

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Produced by American Express, VantageScore Solutions and TransUnion

Financial Counselor Kumiko Love helps single mother Nefertiti Leach get a handle on her increasing debt load.

The average American owes over $50,000–from credit cards to mortgages, medical payments, student loans and other forms of debt.

 

So, how do you handle your debt load? What can you do to get your existing debts under control? Where is the light at the end of the tunnel and how can you prepare for that future?


THE GAME PLAN

There are three key indicators that provide the best picture of your financial health

The first indicator is where we start: your cash flow. This is the calculation that quantifies what’s coming in and going out of your finances each month.


To calculate your cash flow, sit down with your bank and credit card statements for the past month and run this simple cash flow equation:

 

Net Cash Flow Equation

Your cash inflow would include your salary or wages, any interest earned from savings accounts, and dividends from investments. Outflow is what you pay for costs like rent or mortgage, utility bills, gas, groceries, and entertainment.


If you have a positive cash-flow, this is a sign that your finances are in healthier shape. You may be able to consider investing more in your future. If your cash-flow is negative, then this is the place to start your Game Plan. You can begin by focusing on lowering costs, getting a handle on your debt and increasing your cash inflow.

 

While your debt may feel like it’s in a downward spiral, the Debt-to-Income Ratio (DTI) is a calculation you can run to identify the scale of the challenge in front of you—and begin to take control. It’s a key measurement for your financial health.

Debt to Income Ratio equation infographic

DTI ratio can reveal how much of your gross monthly income goes toward debt payments. The conventional wisdom from finance experts is to try and keep your debt payments below 40% of your gross monthly income. If you’re below 40%, then your debt may be more manageable than it currently feels. If you’re DTI is running above 40%, you may want to implement one of three popular debt-reduction strategies:

 

  • DEBT SNOWBALL: Focus on completely paying off your smallest debt balance first. Then move on to the next-smallest balance. You’ll be able to celebrate small pay-off victories as you tackle your debt one small step, by one small step.
  • DEBT AVALANCHE: Focus on aggressively paying down whichever portion of your debt carries the highest interest rate, even if that account has a big balance. In the short term, you may struggle to feel immediate progress. In the long term, however, this can save you hundreds or even thousands of dollars in interest payments.
  • DEBT CONSOLIDATION & REFINANCING: It may sound frightening to take on another loan, but for those with a stronger credit score and income level, this can be an effective tool for crushing your debt. Debt consolidation or refinancing involves taking out a new loan with more favorable payoff terms in order to pay off your higher-interest debt. A lower interest rate ensures that more of your payment each month goes toward paying down your principal balance.
With these debt payoff methods, it’s crucial you don’t forget to pay the minimum payments on all your other debts. You can borrow money from your retirement accounts, such as IRAs and 401(k)s, to pay down high-interest debt, but there are facts and tradeoffs of doing this. Be sure to educate yourself on these tradeoffs and consult with a financial advisor regarding your particular situation.

NO INVESTMENT ADVICE. The content of this webcast is for informational purposes only. You should not construe any information or other material contained herein as legal, tax, investment, financial, or any other type of advice or as a recommendation to take any specific action by any entity or person. All Content is information of a general nature and does not address the circumstances of any particular individual or entity.

 

All investments or investment strategies involve the risk of loss. You should not use this webcast to make financial decisions. You should seek professional advice from someone who is authorized to provide investment or other financial advice.