If your finances are in the red heading into the new year, you’re not alone.
Total debt across U.S. households reached $16.51 trillion in the third quarter of 2022, exceeding pre-pandemic levels and reflecting a surge in consumer prices and demand. The biggest contributors were credit card balances, which increased at their fastest pace in two decades, and home loans.
If you’re worried about a debt hangover in 2023, you can set up a plan of attack. Here’s how you can review your finances, figure out which debts to prioritize and choose a payoff strategy.
Assess Your Financial Standing
The first step of repaying debt is organizing the details of what you owe, your recurring expenses and your monthly income. Gather the info in one place, whether that’s on paper, a spreadsheet or an app.
- Details about what you owe: Create a list of your debts, which may include your mortgage, student loan and credit card balances—anything you’re on the hook for paying down each month. Write the balance, interest rate (and whether it’s fixed or variable), minimum monthly payment, and due date for each.
- Recurring expenses: These are your necessities such as groceries, utilities, insurance, gasoline, child care, transportation costs, cell phone bill, and so on.
- Your monthly income: Go through your pay stubs from the last few months to figure out how much you bring home after taxes in a typical month.
Add up your minimum debt payments and recurring expenses, and subtract the total from your take-home pay. You may also decide to reserve some money for fun spending. What’s left is the amount you can put toward debt repayment each month.
Figure Out Which Debts to Pay First
Having multiple debts can feel overwhelming, and it’s costly to repay loans over a long period of time because interest adds up. That’s why financial experts recommend zeroing out your balances one by one. But every person’s situation is different, says Leslie Tayne, a debt resolution attorney based in New York. So while she offers guidance on which debts to tackle first, you might choose a different strategy.
Mortgage Debt: It Depends on Interest Rate and Type
You take on mortgage debt when buying a home, but also when you borrow from your home equity. This type of borrowing increased over the past few years as mortgage rates reached record lows and home equity grew for millions of homeowners. Cash-out refinances increased by 20% from 2020 to 2021, while home equity lines of credit (HELOC) reached a 15-year high during the first half of 2022.
Tayne suggests paying down your HELOC balance if it has a high interest rate and you plan to be in your home for several years. If your first mortgage has a high interest rate, Tayne suggests making an extra payment toward the principal whenever you can. This reduces the interest you pay over the life of the loan, which may be your best option when refinance rates are high.
But if your mortgage is the only debt you have and you were fortunate enough to score a low rate, “that’s not necessarily a debt you want to rush to pay off,” Tayne says. You might want to save or invest your money while paying down the loan over time.
Credit Card Debt and Personal Loans: Pay It Down
Total credit card debt reached $930 billion in the third quarter of 2022, just shy of the all-time record, according to the Federal Reserve Bank of New York. Additionally, Experian data shows the number of personal loan accounts increased by 16%.
“The rising credit card usage has really been driven by the cost of living, by inflation,” says Jackie Boies, senior director of partner relations at Money Management International, a nonprofit credit counseling agency. “People are spending more at the grocery store, at the gas station, on utilities and so on. If you’re a renter, chances are your rent went up this year. These increases are really putting a damper on people’s budgets. They’re beginning once again to rely on credit cards.”
The Federal Reserve’s rate hikes could further impact credit card holders in the coming months and compound the problem.
Credit cards and personal loans usually come with high interest rates and the debt can impact your ability to qualify for credit, so Tayne suggests paying down these balances quickly.
Student Loan Debt: It Depends on the Type
However, the government doesn’t control payment details for private student loans. These tend to come with fewer borrower protections, higher costs, and interest rates that may vary over the life of the loan. That means your monthly payments could increase when market interest rates rise.
So if you have private student loans, especially ones with variable interest rates, “now’s the time to pay those off because interest rates (in the market) are really high,” Tayne says.
Choose a Debt Payoff Strategy
Once you’ve figured out which debts you want to repay in 2023, it’s time to choose a strategy. Each month, you’ll pay the minimum on all your balances and put your extra money toward the debt you’re targeting. There are two main strategies to choose from:
- Pay off highest-interest debt first: Start by putting extra money toward the account with the highest APR until it’s paid off. Then move to the account with the next-highest interest rate.
- Pay off the smallest balance first: Pay off your smallest balance first, then move to the next-smallest balance until all your debts are paid.
Paying down your high-interest debt first is the most cost-effective because it minimizes the total interest you pay. However, “you can get some really quick wind by snowballing your money toward the small debts first and pay them down fairly quickly, and it feels good,” Boies says. Plus, you free up money in your budget each time you pay off a small balance.
You can choose the method that works for you, or do a combination of both. Just be sure you’re not adding to your credit card balance while you pay down debt.