The current COVID-19 recession has made personal finances a priority for many Americans. While many face serious financial hardship due to rising unemployment, others who have been fortunate enough to adjust to remote work have seen little, if any, reduction in their income. And with fewer travel and entertainment opportunities, some are even finding more money in their pockets than they anticipated.
While proactive debt management is expected to play a major role in the financial plans of people from both groups, those who saw their financial situation improve during the pandemic have a unique opportunity with historically low interest rates to refinance. debt and refocus cash flow. Here are some strategies to get you started in debt management.
Before you can take any action, you must first understand the essential information about all of your debt, such as: What type of debt is it? Is it secure or not secure? What are the interest rates and minimum payments required? Aggregation software such as Mint can also help here.
Once you have a clearer picture of your debt landscape, then you need to adopt a debt management strategy. Generally speaking, you need to decide whether to focus on refinancing, paying off, or extending payments for as long as possible. The best route depends on the type of debt as well as your specific financial situation.
During recessions, central banks lower interest rates to encourage spending and borrowing. These efforts also offer people who are already in debt the opportunity to refinance. Debt refinancing is often a good strategy for people with a high credit rating and a large amount of higher interest debt.
The purpose of refinancing is to reduce interest rates or extend the term of a loan. The larger the debt, the more impactful the refinancing. Take the case of a 20-year mortgage and a refinancing opportunity that cuts the interest rate from 4.5% to 3%. On a loan of $ 400,000, this will reduce the monthly payment from $ 2,531 to $ 2,218 per month – a monthly savings of $ 313.
Refinancing a student loan can also generate significant monthly savings. A 10% to 3% refinance could save a borrower $ 100,000 in loans over $ 350 per month over a 10-year repayment. And many businesses are now offering benefits previously offered only through federally administered loans, such as the ability to defer payments in the event of job loss.
For credit card debt, balance transfer credit cards can also help lower monthly payments and overall interest charges. A borrower can transfer the existing balance of a high interest credit card to a new card with a lower interest rate, which saves on interest.
Keep in mind that because refinancing typically increases the principal amount owed, it may be best for people with relatively low loan balances to stick to their current repayment plan.
Borrowers may prefer to redirect cash flow to repay their balances. This option works best for people with high incomes, cash on the side, and small debts. And because the COVID-19 pandemic is limiting spending options, a borrower who takes this freed up money and spends it on debt will not “feel” it the same way they might if they did. could go out and spend more.
For borrowers with a lot of debts, which ones need to be paid off first? One school of thought suggests that borrowers should make additional payments on their smaller debts first to reduce quick wins. Another method is to pay off the debts with the highest interest rates first to save the most on interest payments.
Whichever method you choose, involve your lender. Especially during economic downturns, lenders are concerned about defaults – so most will be willing to work with borrowers to put in place the more prudent repayment plans.
While most people don’t like taking on debt, there are times when staying in low-interest debt is the best way to increase net worth in the long run.
There is no hard and fast rule about which debt you have to pay first and just need to make minimum payments on. As a general rule, the lower the interest rate, the better it is to make only minimum payments. For example, suppose you refinanced your mortgage and student loans at a rate of less than 3% and invest your excess cash in a diversified investment fund instead of paying off your debt. Over the long term, this investment can generate an average return of over 7%. While you are paying 3% interest, you can earn 7% on the money you would have otherwise sent to a lender. Over the years, this difference can turn into a very large nest egg.
This year has been difficult for just about everyone. If you’re looking for the silver lining, you may be able to take advantage of this year’s low interest rates and reduced spending to refinance your debt or pay off your debt faster.
Ultimately this year will be in the rearview mirror, and smart debt management measures can now put you in the game towards a brighter financial future.