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Understanding Debt

Debt can keep you up at night worrying but it can also be the means to the home you always dreamed of or the education you need to get the job you want. In other words, not all debt is created equal. If you’re already in debt or you’re worried about going into debt, read on for our guide to the subject. Understanding debt is critical to both financial literacy and financial security.

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Consumer Debt

American households together have over 11 trillion dollars in debt. In most households, a mortgage makes up the biggest share of all debt. Then there are auto loans and student loans, not to mention credit card debt.

Not all this debt comes under the heading of “consumer debt.” A mortgage on a home that will appreciate isn’t considered consumer debt. Credit card debt you racked up while buying clothes or eating at restaurants? That’s considered consumer debt because it’s debt that you acquired to consume something that’s not durable and won’t appreciate.

The category of consumer debt overlaps somewhat with the category of so-called “bad debt.” Bad debt is debt that won’t get you anywhere. Student loans for a degree you need to get a high-paying job? That’s generally considered good debt. Debt you accumulated while buying things you don’t need is bad debt. If you have to charge an interview suit in order to jump-start your job search, you might be able to argue that’s good debt. Taking out a high-interest payday loan to buy an expensive engagement ring that will take you years to pay off? Bad debt.

Debt Relief

Understanding Debt

One way to chip away at your debt is to cut back your spending and stick to a strict budget. You could also look for ways to bring in more income that you can dedicate to paying off your debt. Having a “side hustle” can take your debt repayment into high gear. Can’t do either of those things, or you’ve already done them and you want more help with debt relief? We hear you.

Depending on the type of debt you hold there are different debt relief strategies. Medical bills can sometimes be negotiated down, particularly if you talk to the hospital or insurance company promptly after you receive the bill. A trip to the courthouse can lower your monthly child support payments if your income isn’t high enough for you to pay what you owe. Federal student loans have an income-based repayment option, allowing you to lower your debt payments to match your income. Meeting with a non-profit credit counselor can help you figure out the strategies that are the best fit for your needs.

Credit Card Debt Relief

Credit card debt relief deserves its own category because it’s some of the toughest debt to tackle. Annual interest rates on credit cards can top 24%. And did you know that just making the minimum payment can drive consumers further into debt? Seriously.

Minimum payments aren’t listed on your credit statement for your benefit. Studies show that when consumers don’t see a minimum payment they’re inclined to pay much more each month. The minimum payment makes you inclined to pay less. That means you’ll pay more interest over the course of more months.

If you want to break free of your credit card debt, you’ll need a debt management plan that’s specific and attainable. Some folks who have credit card debt decide to tackle the debts with the smallest balances first (sometimes called the snowball method). That way, they’ll get a burst of motivation every time they check a debt off their list. Others decide to start with the cards that carry the highest interest rates (sometimes called the avalanche method). Their goal is to decrease the total interest they’ll pay to creditors over the course of their lifetime.

If you decide to work with a non-profit credit counseling organization, they may put you on a customized debt management plan whereby you pay the credit counseling organization and they pay your creditors on your behalf. Participating in such a program may qualify you for reduced finance fees (read: interest) and help get collection agencies off your back.

Whether you decide to work with a counselor or go it alone, the debt repayment strategy you choose should be one that you’re confident you can stick with. Perseverance is key to getting out of debt.

Bottom Line

Understanding Debt

Debt is not a death sentence. It can be an opportunity to evaluate your financial priorities and simplify your life. Start by contacting your credit card company and any other lenders. Ask them to negotiate your debt and work with you on a payment plan. Or, if you have a lump sum at your disposal, propose a debt settlement. All these steps are actions you can take yourself, for free. You don’t need to add to your financial burden by paying someone to call your creditors for you.

Still need help? Consult a reputable non-profit credit counseling service. Bankruptcy is there as a last resort, but you must seek credit counseling from a government-approved organization within six months before you can file for bankruptcy anyway. The sooner you work out a debt management plan, the better you’ll sleep.

Photo Credit: © iStock/PeskyMonkey, © iStock/DNY59, © iStock/Mark Bowden

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Amelia Josephson Amelia Josephson is a staff writer covering financial literacy topics at SmartAsset. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.

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