The term “consumer debt” describes money owed to others, excluding a home mortgage. It includes credit cards, car loans, student loans, lines of credit, and other debts. There are two types of consumer credit: revolving credit (where a balance can be carried forward month to month) and installment credit (fixed monthly payments for a specified time).
High consumer debt is a problem for many U.S. families and there is no easy way out. Rather, there are small steps that can make the situation better over time. It is impossible to borrow your way out of debt because new debt will just make things worse. The solution, instead, is taking positive action. Below are five specific action steps:
¨ Maintain a Low Consumer Debt-to-Income Ratio– Monthly consumer debt payments should not exceed 20% of take-home (net) pay, which is consider a “danger zone.” A debt ratio of 10% to 15% is even better, especially for people living in high-cost states and/or those with high ongoing expenses such as child care.
¨ Drive a Less Expensive Car– When people spend less on a car, say $17,000 instead of $26,000, they can take out shorter loans, make lower monthly payments, and/or be underwater (i.e., owing more than your car is worth) for less time. Purchasing options include a smaller, lower-cost new car or a late model “new used” car in good condition. Services that comparison shop and negotiate prices on a buyer’s behalf may also be useful.
¨ Do a PowerPay Debt Acceleration Calculation– PowerPay is a free Utah State University website that shows how much time and interest can be saved by accelerating debt repayment. If people have multiple creditors, PowerPay will create a calendar of monthly payments. As each debt gets repaid, its payment gets applied to payments for remaining creditors. Debts can be accelerated in order of highest interest rate, lowest balance, and shortest payoff term.
¨ Earmark Extra Income for Debt Repayment– Sometimes, it may be possible to apply a large lump sum toward reducing or eliminating debt. Sources of extra cash can include working overtime, freelance work, reducing household expenses, expenses that end (e.g., child care), completing a savings challenge, and/or receiving a raise or bonus.
¨ Get Help When Needed– Non-profit credit counseling agencies can assist people whose consumer debt has gotten out of hand. They may be able to negotiate concessions from creditors (e.g., waived late fees and lower interest) but will probably require clients to surrender their credit cards to not run up additional debt.