If you're struggling to get a handle on debt, a financial advisor may be able to help. They can also provide other services, such as investment advice, income tax preparation, and estate planning. Here is what you need to know about hiring and working with an advisor.
- A financial advisor can help create a plan for getting debt under control.
- Typically the plan will be to pay off the debts with the highest interest rates first and then work down the list.
- Anyone can call themselves a financial advisor, so it's important to look for one with solid credentials, such as a certified financial planner (CFP).
- Financial advisors are often paid on an hourly basis. There are also fee and low-cost services available.
Planning for a Budget to Pay Off Debt
Managing debt is a key component of how a financial advisor can help you plan for a healthy financial future. A person overwhelmed with debt is like someone bleeding from an open wound—the first step is to stop the bleeding. A capable advisor can map out a client's cash flow and identify existing and potential problem areas.
The client should bring all relevant documents to their first meeting to ensure that the advisor gets the full picture. This includes bank statements, credit card bills, installment loan statements, pay stubs, tax returns for the past several years, and anything else that may have an impact on their financial situation.
Some people might feel uncomfortable having a person they've just met taking a critical look at their spending habits and past money decisions. But for the meeting to be productive, the client should recognize that they might face some hard truths.
Once the client gets past this obstacle, the financial advisor can help them draft a budget that covers the essentials while not adding more debt to the pile. This typically involves trimming off any unnecessary expenses, so the money that's left over can be used to pay down existing debt.
Analyzing and Restructuring Debts
There are many different types of debt. Some debts are relatively benign, such as mortgages, which generally have low interest rates and help families put a roof over their head. Others can downright toxic, such as credit cards with exorbitant interest rates and things like payday loans.
After analyzing the debt held by the client, the financial advisor can begin to prioritize the client's debt payback strategy. If they have delinquent accounts, those will usually go on top, followed by accounts with the highest interest rates. Delinquent accounts can have a devastating effect on a person's credit score, so getting them back on track is a high priority. Accounts with more modest interest rates will be lower on the list, but the client will need to keep making at least the minimum monthly payments on them so they don't backslide into delinquent status and start racking up penalties.
Paying off debts in order of their interest rates, from highest to lowest, is sometimes referred to as a debt snowball strategy.
The financial advisor will also look at options for restructuring and consolidating the debt. For example, a homeowner with equity in their property may be able to take out a home equity loan and use that money to pay off their credit card balances in one fell swoop. The home equity loan is likely to carry a considerably lower interest rate and also gives the homeowner just one bill to deal with.
The client should be prepared to do some of the legwork themselves. Most financial advisors just advise their clients about what to do, leaving them to handle the loan application process and related matters.
As the new budget takes effect, the accounts become current, and the balances are gradually reduced, the client's credit score should increase accordingly. That opens the door to renegotiating terms with creditors (at lower interest rates) and may even have a positive effect on seemingly unrelated things, such as insurance premiums. Auto insurers, for example, sometimes use credit scores in setting the rates they charge.
Creating a Long-Term Plan
The goal of meeting with a financial advisor isn't necessarily to pay off debt as quickly as possible. While the initial focus may be debt reduction, there are often other considerations that arise once the immediate fires are put out. While each situation is different, it's the financial advisor's job to take a holistic view to establish a long-term plan suited to each client's specific needs.
For example, a person with dependents may need life insurance to provide for them in case of premature death. The financial advisor might recommend paying down a couple of high-interest accounts first, but then slow down the debt payments to buy a life insurance policy or start an emergency fund for unexpected financial crises. The next step may be to start a retirement savings account (or boost contributions to an existing one) once a few more debts are fully paid off.
The advisor should provide the client with a written plan that clearly spells out the recommended course of action. Ideally, the financial advisor should include milestones to check off and red flags to watch out for so that the client can check their progress and catch any potential missteps early.
How to Find a Good Financial Advisor
Anybody can call themself a financial advisor, so it's important to check on the credentials of any advisor you might be considering. The best bet will often be a certified financial planner (CFP) or Chartered Financial Consultant (ChFC). Some advisors have both of those credentials.
In particular, you may want to look for a CFP who is a member of the National Association of Personal Financial Advisors (NAPFA). NAPFA members are fee-only advisors, meaning that they are paid entirely by the client and don't receive any commissions on investment or insurance products that could potentially bias their advice.
Your financial advisor should also be a fiduciary. That means they are obligated to act in your best interest at every turn. A person can be a financial professional and know everything about money, but if they aren't a fiduciary, you'll have fewer protections on the advice you're getting.
This may seem like a minor detail, but it could be the difference between being advised to pay down a 25% interest credit card or starting a brokerage account at $200 per month. The latter may technically not be an unsuitable product and thus not wrong, but a fiduciary would in all likelihood recommend paying down high-interest debt before making any new investments.
Narrow down your list of local advisors by asking around for referrals. Start by talking to any friends or family members who have worked with an advisor in the past. Your tax preparer, if you use one, may be able to offer recommendations, too.
Beware of anyone who promises that they can negotiate with your creditors to lower your debts or erase them entirely. Debt relief and credit repair scams are rampant.
How Financial Advisors Are Paid
With the immediate focus being debt management, a financial advisor's pay structure should usually be an hourly rate. In some cases they may propose a flat fee for creating a financial plan. Investopedia has found that hourly fees of $100 are relatively common, although some advisors charge considerably more. So it's always worth asking in advance.
There are also free (or low-cost) sources of credit counseling help if you are unable to pay for advice. Two reputable organizations that can refer you to a credit counselor are the National Foundation for Credit Counseling (NFCC) and the Financial Counseling Association of America (FCAA).
Do Debts Affect Your Credit Score?
Having debts that you are making regular, timely payments on can be good for your credit score. However, late payments and debts you have defaulted on will hurt your score, often severely.
How Long Do Bad Debts Stay on Your Credit Report?
Most debts, good or bad, will stay on your credit report for up to seven years.
What Is a Fiduciary?
In the case of a financial advisor, a fiduciary is someone who has a duty to act in their client's best interests rather than their own. If a fiduciary breaches those duties they can be held legally accountable and sued for damages.
The Bottom Line
If you are overwhelmed with debt, a financial advisor may be able to help you prioritize your debts and get them under control. But look for an advisor with good credentials and beware of anyone who says they can make your debts disappear like magic. They can't.