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The past year has fractured our world in countless ways. Now, as people look to pick up the pieces, those managing debt need to account for their position in our uneven economic recovery.
In this so-called K-shaped recovery, one part of the population is rebounding quickly while another has a longer, slower path. For example, in January the unemployment rate for whites was 5.7%, compared with 8.6% for Hispanics and 9.2% for Black workers and 6.6% for Asians, according to the Bureau of Labor Statistics.
Those who remain unemployed or underemployed might continue to rely on debt to get by. Meanwhile, those whose finances have held steady or improved may be primed to wipe out debt.
Economists and politicians are trying to predict how the economy can bounce back from the earlier crash brought on by the pandemic. Here are the most common shapes of recovery and what they mean for you and your investments.
Managing debt in the bottom half
Some consumers have had no choice but to rack up debt — including unpaid rent or mortgage, credit card debt and overdue utility bills. If this is your situation, focus on basic needs and paying minimums to avoid collections.
Protect the essentials
If you’re among the millions of Americans unable to cover your housing costs right now, take advantage of the eviction moratorium and mortgage relief programs now extended through June 30. Keep an eye out for additional benefits in the COVID-19 relief package being discussed in Washington and call 211 to get connected to local assistance for basic needs like food and shelter.
Add transportation, internet and cellphone to your priorities list, too, so you can stay connected to friends and family for help and to hunt for work.
“All creditors will make it sounds like they’re the most important ones to get paid,” says Amanda Christensen, a financial coach based in Morgan, Utah. “Housing and transportation have to come to the top of that list and take priority.”
If needed, look for cheap credit
If you need to add debt to cover your regular expenses, like groceries and utilities, financial coach Vineet Prasad of Fulton, California, suggests finding the cheapest options. “A revolving credit line on your home equity has a much lower APR than a credit card. Another option is a personal loan at a credit union.”
To qualify for a HELOC, you’ll generally need equity of at least 15% of your home’s value. And weigh the risks: HELOCs tend to have adjustable interest rates, which can make them more expensive over time, and your house is at risk of foreclosure if you can’t repay the debt.
Focus on long-term recovery
Once your situation stabilizes, focus on paying down debt and make savings a priority, too.
Consider using a debt payoff calculator that can track your debts and monthly payments. And while you may be tempted to throw all your spare income toward debt payoff, having some cash tucked away can help you weather the next financial crisis.
Saving even a small percentage of your income helps, Christensen says: “If you’re not saving anything right now, see if you can get in that 1% to 5% range.”
Managing debt in the top half
If your finances held steady or improved over 2020, think about how you can take advantage of your situation, whether through charitable giving or using some of your cash to improve your finances.
And if you’re focused on reducing debt, the classic payoff playbook works well: First, take stock of what you owe. Consider using a spreadsheet or online debt tracker to organize your balances.
Also read: Here’s why it matters that the Dow keeps hitting new highs
Then choose a payoff strategy, like the debt snowball method where you focus on your smallest debt by paying as much on it as you can while paying minimums on the others. Once it’s paid off, roll the amount you were paying on it into the payment for your next largest debt and so on until you’re completely debt-free.
Paying off debt can be a long-haul game. To stay focused, Prasad advises finding someone who can serve as a confidant and provide encouragement.
“Getting an accountability partner who is good at managing their money generally can be a huge differentiator with actually following through with your plan and the grind of paying it off over time,” he says.
Anyone can have overwhelming debt
Regardless of your income or employment status, you may have too much debt to realistically pay off with a strategy like debt snowball. If all your monthly debt payments, including housing, total more than 50% of your monthly gross income, you may need to look into debt relief, like a debt management plan at a nonprofit credit counseling agency or bankruptcy.
The goal is to resolve your debt quickly and in a way that sets you up to meet future financial goals. Otherwise, you may spend years funneling money toward insurmountable debt, sacrificing retirement, an emergency fund and other goals.
Bankruptcy in particular may be a good option, as it can help you resolve what you owe in a matter of months instead of years. While bankruptcy filings were down 30% in 2020, according to the American Bankruptcy Institute, that may change in 2021 as consumers’ financial pictures begin to stabilize.
Read more: Housing is a luxury? Here’s what the K-shaped recovery means for real estate
To make the most of the fresh start bankruptcy offers, don’t wait so long that you can’t even afford the filing fees. Act when you are in a position to improve your financial situation, says bankruptcy attorney Cathy Moran of Redwood City, California.
“When you’ve hit the bottom and things are about to get better, that’s when you want to file,” Moran says.
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Sean Pyles writes for NerdWallet. Email: spyles@nerdwallet.com. Twitter: @SeanPyles.
