Consumer debt may have receded a bit immediately after the financial crisis of 2008, but today Americans have heightened the amount of outstanding consumer debt to more than $3 trillion, according to the Federal Reserve. Want to sidestep this dangerous trend? Here are the five of the top debt traps Americans face and how you can safeguard yourself from them.
1. Job lossThe unemployment is steadily improving, but the level remains solidly above 7 percent. According to Patricia A. Hasson, president and executive director at Clarifi, a non-profit consumer credit counseling service, unemployment or underemployment is the No. 1 reason people seek financial counseling. Safeguard: Having an emergency savings fund totaling three to six months' living expenses can help bridge the gap between jobs, if necessary, or temporarily buttress lower wages from underemployment. "The task of saving an entire six months worth of expenses can be daunting," says Hasson. Instead, she suggests savers start small and take it step by step. "Pick an amount you can save each month and have a clear dollar goal in mind. Even better if it can be set up through an automatic transfer."
2. Medical costsThe costs of an unexpected illness can be debilitating, even for those with health insurance. More than 20 percent of Americans currently struggle with health care expenses, and medical costs are now the leading cause of bankruptcy. According to Christina LaMontagne, vice president of Health at NerdWallet, "Insurance is no silver bullet. Even with insurance coverage, we expect 10 million Americans will face bills they are unable to pay." Safeguard: It can be tempting to choose lower health coverage to bring down a monthly premium. Those with chronic health conditions or medication needs, however, should consider a more robust plan. According to LaMontagne, millions forgo needed medication to mediate costs and, as a result, can face substantially higher emergency and ambulatory costs. In the end, prevention can be a much cheaper alternative.
3. Credit card overuseWhen expenses go up but income doesn't, many turn to credit cards to bridge the gap. The average American household with at least one card carries almost $15,950 in revolving debt. Assuming a 18.9 percent interest rate and a minimum required payment of 2 percent of the balance, it could take over 30 years to pay that off, including a staggering $46,000 in interest payments.
Safeguard: Avoidance is the best protection. However, according to a recent Federal Reserve Bulletin, over half of cardholders carry a balance and 10 percent are at least 60 days past due. When managing credit card debt, Hasson suggests paying off the cards with the highest rates first. "Using one card to pay another can be a warning sign that someone is in over their head," she says. "A debt counselor can help develop a solid financial plan. Most important is to not avoid creditors (if you're struggling). It can only get worse if you do."
4. Loss of a partnerWhether by divorce or death, loss of a partner can be financially devastating. According to Violet Woodhouse and Dale Fetherling in their book, "Divorce & Money: How to Make the Best Financial Decisions During Divorce," the loss of a spouse can make a bad situation even worse. "Many people today live beyond their means," reads the book. "When it comes time to divide one household into two, there is rarely enough money to go around. This holds true as much for young married couples with little property as it does for wealthy couples with assets accumulated over many years." Safeguard: "You can't anticipate divorce or the loss of a spouse," says Hasson. "If it happens and you have nothing saved, your expenses are only going to go up. It can be even worse for those carrying debt." Paying down debt and building savings can provide a buffer if tragedy strikes.
5. Student loansThe average education loan balance among borrowers is more than $24,000 and 66 percent of all bachelor's degree recipients incur student debt. Nearly 42 percent of those still paying back their loans beyond the age of 30. Safeguard: In some circumstances, student loan payments can be temporarily postponed through deferment or forbearance programs and even sometimes forgiven. Federal lenders also offer extended payment and loan consolidation programs, which can extend the loan term and lower monthly payments. While it's best to to prepare ahead for financial turbulence, life's challenges are often unexpected. "A budget session can be beneficial for anyone at any income level," says Hasson.
A certified counselor can help set priorities and uncover ways to save each month. If you struggle to avoid debt on your own, check the National Foundation for Credit Counseling for a non-profit organization near you.