Most Americans carry some form of personal debt. In fact, 77 percent of Americans have debt, according to the 2018 Northwestern Mutual Planning and Progress study.  And, if you have significant levels of debt, you need a financial plan to manage your debt and get out of it. That’s because debt can cost you money, potentially a lot of money for a long period of time.

In fact, if you take the time to tally how much you’re paying in interest over the life of your debt, it might just be the motivation you need to finally make a big push to pay off your debt so you can spend that money on something you enjoy or can invest in your long term financial freedom.

The Northwestern Mutual’s 2021 Planning & Progress Study showed that among U.S. adults aged 18+ who carry debt, they hold an average of $23,325 excluding mortgages. This represents a downward trend of over 20% since 2019.

While overall debt is on the decline, 30% of Americans’ monthly income on average goes towards paying off debt other than home mortgages.

Far and away, the top source of debt after mortgages is credit cards, accounting for more than double any other source, according to the study:

• Credit card bills – 19%
• Car loan – 8%
• Education loans – 7%
• Home equity/lines of credit – 4%

Debt under control, or controlled by debt?

When prioritizing debt versus savings, the interest rate on your debt is a key consideration. The higher the rate, the more you stand to save by paying off the debt.

But also consider the type of debt. A debt can be “secured” or “unsecured”. A secured debt is backed by an asset, also called collateral. Auto loans and mortgages fall into this category: Both allow the lender to repossess the asset if you stop paying the loan. In other words, they can take what you bought with the loan and sell it to get their money back.

With debt consuming nearly a third of monthly budgets on average, many people also say that it has negatively impacted their ability to pursue other financial milestones. Because of Americans personal debt:

• 29% delayed making significant purchases
• 18% delayed saving for retirement
• 14% delayed buying a home
• 8% delayed having children
• 7% delayed marriage

Having to pay down debt also carries weight in the way people feel about their long-term financial stability – 78% say that debt has impacted their ability to achieve long-term financial security.

“The latest numbers show steps in the right direction compared to previous years, but we continue to see debt hindering many Americans from having the financial freedom to make other important decisions in their lives,” said Christian Mitchell, executive vice president & chief customer officer at Northwestern Mutual. “Having a plan of action to manage debt and stay on top of payments is critical to achieving future financial goals.”

Although debt is holding some back from major decisions, there are positive indications that people are looking ahead to manage and reduce their debt. Two-thirds (66%) of those with some debt say they have a specific plan to pay it off, and have a timeline for doing so:

• 45% only expect to be in debt for 1-5 years
• 20% say for the next 6-10 years
• 14% say between 11-20 years
• 9% say for the rest of their lives

The cost of debt can add up quickly. Thus, it’s important to manage the amount and reduce the cost of your debt, and get it paid off. That way you can put that money to work for you financial freedom or toward something more fun, like your next vacation or retirement.

“Rather than lamenting you have too much debt, imagine how much better your life would be with less.”

There’s almost no better way to reduce your expenses and save money than unloading credit card debt. Ridding yourself of this high-interest debt offers returns that few investments can match over multiple years. Even though the S&P 500® has long-run average annual returns of 10%, most people should only expect to earn about 6% a year on average because they’ll hold a mix of assets (including bonds) that lowers their overall risk (and expected returns).

Here are several recommendations to assist you manage your debt and to think through what’s best for you and your money, according to Northwestern Mutual:

1. COME TO GRIPS ABOUT SPENDING – Debt can pile up for all kinds of reasons. Paying it down should be pretty straightforward — but for that to happen you have to be honest about your spending. Putting your spending into perspective can help you manage and develop a plan to get yourself in better financial shape.
2. GIVE IT A POSITIVE SPIN – Rather than lamenting you have too much debt, imagine how much better your life would be with less or none. Then set specific financial goals with a focus on debt reduction and elimination.
3. AUTOMATE YOUR PAYMENT PLAN – Put as many of your credit card and/or loan payments on auto-pay from your checking or savings account. That way, you’ll be sure to avoid any unnecessary late fees.
4. PRIORITIZE, PRIORITIZE – If you can’t pay all your debts each month, prioritize what you can pay. Give high priority to debts secured by a house or car, necessities like utilities and debts you can’t discharge, including student loans and unpaid federal taxes. Then tackle unsecured debt like credit cards. You’ll want to identify the credit card with the highest interest rate and pay that one off first. That way, you’ll save yourself money by avoiding unnecessary and excessive interest rate charges over the life of your debt.
5. PAY AS YOU GO – It may seem old fashioned, but avoid paying with plastic and start using cash, check or debit card instead. Sure, it will take a little extra planning to make sure you have sufficient cash in your wallet, but doing so can help you clearly connect to where your money goes each day. It may also help you avoid impulse purchases and other unwise spending.
6. MAKE MORE OF YOUR INCOME – Many people believe they don’t have enough money to put toward debt reduction. Ask yourself: Do I really need a latte every morning, or special cell phone services? Sticking to a budget isn’t easy, but if you save small amounts, you’ll be able to pay off your debt that much faster.
7. DON’T LOSE SIGHT OF RETIREMENT – Paying off debt isn’t a free pass to put your retirement savings on hold, especially if your 401(k) at work offers a company match. Even if you’re paying off a high interest rate on your credit card debt, the employer match on your retirement savings makes your retirement plan contribution the better deal.

When it comes to your retirement, you want to make your money work for you. That’s where investing becomes most important. Sometimes, saving and investing makes more sense than paying off debt. With the interest rate on your debt below 6%, you may want to pay off that debt on schedule rather than making extra payments.

As an added incentive, the tax advantages of investing through retirement accounts like 401(k)s and IRAs can help your money go further over time than it would by paying off debt early.

Plus, you can only contribute so much each year to retirement accounts. Every year you don’t contribute is a missed opportunity to save. With many workplace plans, you also miss a chance to earn matching contributions—i.e., free money—from your employer. And thanks to compounding, the earlier you save, the more your investments could grow over time.

Personal debt has its purposes and financial benefits until it becomes unmanageable and you have trouble paying it off. In the worst case scenario, debt can result in you going bankrupt if you’re unable to make your monthly credit card or mortgage payments.

The pandemic has put some Americans behind and has allowed others a chance to gain some ground on their debt. Specifically, 34% say it will take them longer than expected to pay off their debt because of the pandemic, while 23% expect to be able to pay it off sooner.

When it comes to paying off debt or saving money for emergencies, retirement and other goals, your financial priorities will depend on several factors. These include the types of personal debt, their interest rates, your disposable income and your long-term goals. You can weigh your options, depending on how much debt and how much money you already have saved for the future and invested to for the long term.

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References:

1. https://news.northwesternmutual.com/2021-08-25-Northwestern-Mutual-Study-Finds-Americans-Personal-Debt-Has-Dropped-More-than-20-Over-the-Last-Two-Years
2. https://news.northwesternmutual.com/planning-and-progress-2021
3. https://www.prudential.com/financial-education/how-to-pay-off-debt-and-save
4. https://news.northwesternmutual.com/2018-08-14-New-Data-Personal-Debt-On-The-Rise-Topping-38-000-Exclusive-Of-Mortgages
5. https://article.smartasset.com/financial-advisor-secrets-1/