Debt transcends all adult age groups — from those beginning their careers to those in retirement. No generation is immune from potential debt problems. However, there are many ways financial advisors can help their clients manage and eliminate debt.
Complete a Cash Flow Analysis
One of the first things financial advisors should do with a client is complete a cash flow analysis to gain insight into their current financial status. The analysis identifies income and expenses to determine how clients are managing their finances and will highlight whether the client has accumulated debt that should be addressed. Completing a cash flow analysis helps identify whether clients are spending more than they can afford, which ultimately causes debt. This exercise also provides visibility into where adjustments can be made to improve the client’s financial situation.
Set Up a Financial Plan
After completing a cash flow analysis, advisors should help clients set up a financial plan. During this exercise, advisors review the client’s debts against their assets to determine overall net worth. Doing so provides insight into whether the client can meet their financial needs and obligations.
Setting up a financial plan also helps identify the client’s short-term and long-term goals — whether those goals include a vacation, purchasing a home or retiring — and determine the best strategy to meet them.
Take Inventory of All Debt
Financial advisors also should take an inventory of all the client’s debt and compare the interest rates on each credit card or loan with the payment on each account. Sometimes advisors find that people are paying the most money toward their largest debt, assuming it is a good strategy to pay it off. Instead, the best approach is to concentrate on the account with the highest interest rate, which will save money in the long run.
It is also important to ensure clients understand the difference between good debt (mortgage) and bad debt (credit card). For example, while student loans are considered good debt, the amount and length of the loans can impact a client’s overall debt load and affect the amount of a mortgage loan for which they qualify. Once clients have a clear understanding of the different types of debt, they can make better financial decisions such as limiting bad debt in the form of credit card use.
Establish a New Monthly
Once an inventory of all debt is complete, advisors should establish a new monthly payment plan with their client. While clients still can pay approximately the same amount toward their total debt each month, their individual debts will be reprioritized to pay down first those with the highest interest rates. This approach allows the client to continue eliminating payments while also saving the extra money that would have gone toward those debts with the highest rates.
Consolidate Debts and Insurance Coverage
Advisors also should determine whether their client’s debt can be consolidated into a product charging less interest than their current credit cards, which sometimes charge up to 20 percent or more. One option is to renegotiate a mortgage loan and add their other debts to it, creating a single monthly payment at a reduced rate. Advisors can show clients how much quicker this approach will pay off their debt. To pursue this route, homeowners must have enough equity in their properties and a good credit rating to qualify.
In addition to consolidating debt, the other option is to consolidate life insurance coverage. Clients often have separate life insurance policies — one on a mortgage, one on a line of credit and another to cover lost income. Combining the coverage amounts into one contract often provides large savings because the cost of life insurance per thousand reduces as the coverage amount increases. This also means having to make a payment on only one policy premium.
Review Spending Habits
It is also important to review the spending habits of clients and identify where cuts can be made to help pay down debt. Perhaps clients can trim spending on dining out, entertainment, or unnecessary household and personal items. Even savings from simple changes like making coffee at home and packing a lunch for work can add up. This extra money should be put toward high-interest credit card or loan debt.
Evaluate Mortgage Loans
Financial advisors should also evaluate and include any mortgage costs and lines of credit. Clients should meet with their mortgage planning specialist to evaluate what a mortgage will cost them and let their advisor know what could be incorporated into their full plan. Sometimes people unknowingly purchase properties that are too expensive because they underestimate fixed monthly costs. This is also easy to do when clients qualify for high mortgage amounts and low interest rates. When people spend too much income on living expenses, they are more likely to rely on credit cards they cannot pay off, which perpetuates the debt cycle.
Despite how easy it is to create and increase debt, there are many strategies advisors can use to help their clients establish a plan to manage and eliminate debt. Sometimes it starts with simply making clients more familiar with their income and expenses so they make better financial decisions and live within their means. The sooner debt is controlled, the sooner they can start living debt-free and focus solely on saving for their future.