Managing Your Debt

Is there such a thing as good debt? Borrowing for a home – one that you can afford and one that is in keeping with your needs – or borrowing for college is often times called good debt. That also means there is bad debt. Bad debt is charging lunch to your credit card and then not being able to pay off the card balance when it comes due. It’s racking up credit card balances for something that was quickly consumed, something that you can’t afford or something you don’t need.

How do you control the amount and nature of your debt?

Review our Money Basics article and if you haven’t gone through the exercise of preparing your budget, do it now.

Try not to give in to instant gratification. 

Before you charge, save for 3 weeks, 3 months or 3 years for your more expensive purchases.  In general, control your spending on items that are quickly consumed.  If you have a hard time with that, try this tactic.  Decide what you can spend out of this paycheck on non-essential items like dining out, entertainment and clothes and put that amount of cash in an envelope.  When it’s gone, you’re done spending.

Take inventory of your debt.

Use this format (or one that you prefer) to list each loan, its interest rate, monthly payment, the date your payments are due and the maturity date, if this is a fixed term loan.  Facing the reality of your recent spending in terms of the debt you’ve accumulated can be a sobering wake up call. (You can also use this to help you plan your cash flows).  Don’t forget to compare your total monthly payments to your take home pay.  In general, it’s a good idea to keep your consumer payment obligations to no more than 10-15% of your take home pay.  

Reduce your credit card debt. 

Cut back on your non-essential spending.  Use the extra cash to pay down your debt and consider starting with your highest rate of debt first while maintaining at least minimum payments on your other debt.  Once the higher rate debt is paid off, apply that payment to the next highest.  And so on.  Another option is to pay off your lowest balance card.  The cash flow that you free up, once it’s paid in full, can then be applied to your highest rate debt to pay it off faster.  If you have a card with a very small balance, this may be a good choice for you.  And finally, challenge yourself to pay off your cards faster by paying more each month.  If you increase the monthly payment to $75 from its current $45 and don’t charge any more, you’ll pay off the card in 20 months instead of the current 35 months.  You’ll also save $120 of interest.  

Plan for the unexpected.

Build a cash cushion – up to 8 months of living expenses.  The cost to repair the AC unit on your car or a broken washing machine is a quick way to add credit card debt that will hang around for a long time.

Paying your bills on time can pay off with a higher credit score.

A higher credit score can mean a greater likelihood of approval when you apply for a car or house loan.  It can even mean a lower interest rate. 

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