High Income, High Debt: How to Stop the SpiralFebruary 19, 2020
By Caroline Farhat
A lot of people think if you are earning a high income you must have lots of wealth and no debt. However, that is not always reality. In fact, for some people, earning a high income can mean higher amounts of debt. If you are in these circumstances, read on to find out how to stop the spiral.
High Income, High Debt
There are many reasons that higher-income households can have higher debt. One reason is higher earners like doctors and lawyers may have higher debt due to the amount of student loans needed to obtain their education.
But the big problem lies with the high earners who have high levels of debt and no assets to show for their income. A 2015 Nielsen study found 25% of American households earning $150,000 or more were living paycheck to paycheck. These are the earners who may be going down a spiral. There are reasons for this spiral that can be addressed to stop it. Some reasons include:
- Desire to spend – A person earning a high income feels like they have a lot of money they can spend and deserve to spend. However, this can cause some to spend up to the total amount they bring home or worse exceed the amount, causing credit card debt or the need for personal loans.
- Keeping up with the Joneses – Always trying to keep up with your group and show “wealth” you may not really have. This can be seen in the form of always buying the latest gadget, flashiest car or taking a trip to the latest popular destination. Even if you can afford some of these items now, feeling the need to keep up can be dangerous because you never know when a time may come that you may not be able to afford your lifestyle due to sudden job loss or a change in financial circumstances.
- Lifestyle creep – Increasing your expenses when your income increases because of your wants or perceived new needs. For example, the thought that now you need a more expensive and larger house because you can afford it with your higher income.
How to Stop the Spiral
Did any of this resonate with you? If so, don’t panic. You can always stop the spiral of high income and high debt. Below are some actionable steps you can start today.
1. Determine your fixed expenses
Fixed expenses are the expenses that are mostly out of your control and remain constant every month. They include your rent or mortgage, car insurance, internet bill, cell phone bill, utility expenses (although these may not be the same each month you can figure out the average), and loan payments. Knowing these expenses will help you complete the next step.
2. Create a budget
You knew this was coming! Now that you know your fixed expenses you can create a budget. There are different methods you can use to create a budget. One budget that many people find easy to follow is the 50/20/30 rule. The basic principle is subtract your fixed expenses from your take-home pay. Then put money in savings for your emergency fund, retirement, or whatever you determine is most important to you. The rest of your income is used to pay your variable expenses. These are the expenses you have the most control over, like your food budget, restaurants, and clothing shopping.
3. Try to reduce your expenses.
The easiest expenses to try to reduce will be the ones completely in your control, like eating out less. But there are some ways to reduce your fixed expenses.
Refinance student loans – Have a high monthly payment? Refinancing may be a good option. Refinancing student loans can reduce your monthly payment and save you in interest costs over the life of your loan(s). You can refinance private student loans and federal student loans. Check out our student loan refinance calculator to determine what your potential savings could be.*
Negotiate your bills – Have a high internet bill? Or maybe you are still paying for cable. Check for any deals with your provider and compare with competitors. Better yet, think about whether you really need the service. If you are a die-hard Netflix fan, it may be time to cut the cable cord.
4. Pick a method to attack your debt.
There are two methods financial experts recommend to pay off debt: the snowball method and the avalanche method.
Snowball method – Use any extra money to pay off your lowest loan first. Once the lowest loan is paid off you take the payment you were making to that loan and apply it to the second-lowest loan. Here is an example of how it works:
- If you have a student loan of $25,000 with a payment of $290 and an auto loan of $15,000 with a payment of $275 you would focus on paying the auto loan off first. You would make both minimum payments but if you have an extra $25 per month to apply to a loan you would apply it to the auto loan. Once the auto loan is paid off you would apply the payments of $275 and $25 to your regular minimum student loan payment of $290 and now be paying $590 per month to your student loan ($275+25+290 = $590). You would continue this until all debts are paid off.
Avalanche method – List your debts in order of interest rates and start paying off the debt with the highest interest rate first. Add any additional payments to the loan with the highest interest rate. Continue paying the minimum on all other loans. Once the highest interest rate loan is paid off you apply that minimum payment to the next highest interest rate loan.
5. Put salary increases into savings
Don’t give into the lifestyle creep. If you were able to pay all your expenses before your salary increase, you can continue to live off your old income amount and save the increased amount. The difference can be put into a retirement account or savings account, thereby increasing your wealth. The best way to do this is to set up an automatic transfer so that the extra money never hits your bank account. If you can’t see it, you can’t spend it!
If you have realized you are in a high income, high debt spiral, there is hope of stopping it. With some work, you can get your finances in order and begin to see your savings grow.
*Subject to credit approval. Terms and conditions apply.
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