A recent TransUnion Report shows that Americans are changing the way they rank their debt. In the years following the economic crisis in 2008, many focused on paying down their credit cards first – but now they’re shifting their attention to collateral-tied debt such as mortgages and auto loans. These types of debt tend to have larger balances and lower interest rates. And since they’re tied to collateral, defaulting on them results in losing property.
This is quite a change from what is normally seen in the world of personal finance. This shift in focus is also indicative of a shift in repayment methods. The two most popular debt payoff methods are the debt avalanche method and the debt snowball method. Avalanche focuses on paying down high interest debt first while snowball focuses on paying down smaller balances first. The former focuses on spending less money on interest while the latter focuses on keeping you motivated. This new trend applies to…
…neither. Rather, it seems, Americans are now focused on paying off the debt that they see as an investment and/or necessity to their lives, such as shelter and transportation, above all else. Below, we’ll discuss why and how you can strike a balance in your own debt payoff.
Economic Trends Have a Larger Impact on Priorities than Preferred Payoff Methods
While we spend a lot of time on this blog talking about how to strategize debt payoff, economic trends and their implications on the future can easily trump strategy. In fact, when times get really tough, as they did in 2008, debt payoff can almost feel like a luxury. That’s why economic trends both impact the way we prioritize our debt and can be used to predict future behavior.
So what does the latest trend mean?
As highlighted by the report, many Americans had one thing on their mind during the economic crisis: liquidity. Keeping credit cards out of default and trying to pay them down quicker than other debt meant having more available credit in times of need. On top of that, many homes were losing value quickly. Declining home values, combined with suddenly spiking variable interest rates, made the thought of homeowners paying their mortgages off (or even making their payments at all in some cases) seem nearly impossible.
But as the economy stabilized and home values increased, priorities changed. Home value increases mean that homeowners can once again make their payments and see their homes as an investment for their future. Credit cards and the need for liquidity suddenly don’t seem as important and thus get ranked lower on the payoff totem pole.
While there are clear positives in this trend – we’re focusing more on our future and investing for stronger finances in the case of future economic crises – the new trend could actually cost us more money in the long run. Credit cards come with variable interest rates that start off high and can increase quicker than you can say “economic shift”. Mortgages, however, tend to come with much lower interest rates. That means you could lose more money over time if you keep the balances on your credit cards while paying off your home faster. Luckily, there is a way to strike a balance that helps you get out of credit card and mortgage debt faster – thus keeping your finances and your home intact.
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Striking a Balance in Debt Payoff
Every situation is unique so it’s important to strike a balance when deciding on a debt payoff method. While ReadyForZero will always prioritize high interest credit card debt over mortgages and student loans, it’s completely understandable that many might prefer to pay down a sometimes overwhelming 30 year mortgage first (especially if it has a variable interest rate). Here’s how you can do both:
Pay Your Mortgage Off Faster with Biweekly Payments.
If you only have limited funds to apply to your minimum payments on debt, then you can use biweekly payments to pay your mortgage off faster without dipping into those funds. How it works is you would split your monthly payment in half and then apply that payment every other week. This will end up amounting to one extra payment per year and can take years off the life of your mortgage – not to mention thousands of dollars saved in interest. Check out this calculator to help you discover just how much you could save.
Apply Extra Money to Credit Cards – then Roll Those Payments to Your Mortgage
No matter how large your credit card debt is, chances are it’s still much smaller than the balance on your mortgage. If you divert any extra funds you have to pay off your credit card (or cards) faster, then you’ll reach credit card debt freedom much sooner than you would paying minimum payments only. And once you do that, all of the money you were applying to your credit card payments can be added to your mortgage payments. That equals paying off both your credit cards and mortgage faster.
While it’s tempting to pay off one debt and keep the extra money that would have gone to payments, it won’t help you if your long term goal is to pay off any other debt you have. And all debt, no matter how low the interest rate or forgiving the terms, costs money. Using either the debt avalanche or debt snowball to roll previous payments to remaining debt will help you reach debt freedom and start building wealth sooner.
It’s impossible to tell what the future may hold. While following economic trends is a good way to prepare yourself, strategizing ways to reach your own financial freedom is the only surefire way to be ready for anything that the economic market may bring. By striking a balance in your own debt payoff strategy, you can ensure that you don’t lose more money to interest than you have to and that you’ll have more liquidity should another crisis strike.
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