Debt is one of the leading causes of continuing financial struggle and affects more than 340 million Americans every day. Indeed, crippling debt was one of the reasons in favor of President Biden’s recent decision to erase up to $10,000 per person of student debt, and as prices rise due to high inflation, 65% of adults are concerned about their ability to afford everyday essentials with their current income. Yet according to Northwestern Mutual’s 2022 Planning & Progress Study, American debt levels have fallen an astonishing 25% over the past three years.
Debt levels have fallen but remain high
Although accessible credit has increased Americans’ ability to purchase goods and services, it has also normalized debt across the country.
A recent study by Northwestern Mutual has found that the average U.S. adult currently carries $22,354 in debt exclusive of mortgages – down from about $30,000 in 2019. Perhaps unsurprisingly, the majority of personal debt comes from credit card debt, followed by education and car loans.
High levels of debt have negatively affected Americans’ ability to reach major milestones, resulting in delays in getting married, buying a house, having children and saving for retirement. More than half of the study participants responded that debt has a substantial to moderate impact on their ability to reach financial security, and 43% of those that carry debt expect to stay in debt for one to five years.
The authors note that they last collected data for the study in February 2022, right when inflation began to rise and the COVID-19 pandemic’s effects were dwindling. Over a third of respondents said they had focused on paying down debt and decreasing living costs in 2021 as a result of the pandemic, but that number had dropped to 21% by 2022.
“With inflation rising at the fastest pace since the 1980s, many Americans have seen their savings begin to erode and their debt levels rise in recent months,” said Christian Mitchell, Executive Vice President at Northwestern Mutual.
Americans prioritized paying down debt over saving
Although personal debt levels have fallen 25% over the past three years, those strides forward may have come at a cost. The research found that 32% of Americans’ monthly income goes toward paying down debt other than mortgages, with the majority choosing to pay down debt rather than save. A different survey by New York Life concurred, finding that one in three adults have made no recent progress toward saving for retirement.
But with inflation continuing to erode customers’ purchasing power – their ability to buy homes, cars and basic necessities – is it always wise to prioritize debt repayment over saving?
Experts say that debt can create a drag on finances that is very difficult to reverse. Paying interest over a long time stacks up and can snowball the original debt to extremely high levels. However, when asked about their greatest obstacles to reaching financial security, people said that inflation and lack of savings trumped their worries about debt and healthcare costs.
Which is better: paying down debt or saving?
One of the Four Pillars of Building Wealth is to prioritize savings for a rainy day – like when inflation eats into your budget, a pipe bursts in your house and you end up in the ER with a real medical emergency all on the same day. Part of a healthy financial plan is to create a budget and focus on building up your savings. If you follow a basic 50-30-20 budget, ideally 20% of your pay could cover your debt payments and add to savings at the same time, but many Americans dedicate up to a third of their paycheck to paying down debt.
First, make sure you have a starter emergency fund of at least $400, preferably held in a high-yield savings account. The next move would be to pay down the highest-interest credit card or personal loan debt. With sky-high interest rates often around 24%, it’s in your best interest to pay off those balances as soon as you can. Otherwise, you might want to save for a big purchase but simply not be able to because of growing, crippling debt.
Since other forms of debt typically charge lower interest, you can free up more disposable income by following the snowball method.
Focus on dedicating up to 20% of your income to paying off your highest-interest debt while only maintaining payments on the others. Given how many people overpay their debt to the exclusion of saving, you may be able to roll a little more into your emergency fund or pay for necessities if you limit your exuberance for paying down your debt. Then, after paying off the first balance, you can order your debt by priority or size and pay them off one by one. To keep yourself from falling back into debt, stick to a disciplined approach of paying off your credit cards every month and focus on increasing your income to increase your savings.
Bottom line
Over the past three years, Americans have cut their personal debt levels by 25%. Armed with healthy financial habits learned during the COVID-19 pandemic, many people focused on paying down debt and reducing their living costs to improve their overall financial picture. However, as inflation eats into customers’ purchasing power, more and more adults are finding their savings insufficient and have relied more on credit cards for everyday purchases. Paying down high-interest debt can set the stage for a healthy financial future, but make sure to maintain an emergency fund by increasing your disposable income and spending smartly.
