Manage Debt Effectively

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Obviously, the best thing is to not accumulate debt.  But let’s face it, we all have (or have had) some form of debt at some point in our lives.  And, whether we like it or not, debt plays a major role in everyday life.  The important goal everyone needs to learn, is how to manage debt.  Knowing how much you have accumulated and the concept of good debt are critical first steps to effective debt management.

Take Inventory:

So, what’s the first step to effectively manage debt, take inventory of the debt you currently hold.   Look at your monthly recurring bill payments and start adding:

  1. Auto loan
  2. Student loan
  3. Mortgage (including home equity loans)
  4. Credit card debt
  5. Other (medical, legal, taxes, etc.)

Next, write down line by line, the monthly amount and the interest rate for each of these items.  For example, $300/mo auto loan at 2%.  Once you have a summary of your debt in this type of format, it is easier to analyze.

Good Debt:

Of course, having too much debt is not beneficial, however taking on what is called “good debt” for the right reasons can be useful and have long-term advantages.  So, what does good debt look like?

  • Buying a home – taking out a mortgage and paying it off over time.  
  • Investment property – using a mortgage to buy a second rental property.  Buying a reasonably priced property where the rent can cover your monthly payment.
  • Education – most people need to take-on debt in order to obtain a college degree.
  • Home improvements – specifically those that increase the value of your home (kitchen, bath, regular necessary maintenance).
  • Cash management tool – use to pay-off higher interest debt or consolidate debt.

Develop a Payment Plan:

Now that you have summarized the debt currently held, and have a clearer understanding of what type of good debt you might have, to manage debt, it is time to build a payment plan.

  1. Start with all of the debt not in the good pile: credit cards, auto loans, etc.  Start aggressively paying down the amount with the highest interest rate, while maintaining the minimum payments of any other debt.  Once that is paid, work through the list from highest to lowest interest rate.  
  2. Out of the “good debt” list, look at the interest rate and compare it to your average expected investment return.  If the interest rate is higher than the investment return, then it would be a wise choice to start paying it down.

Does consolidation help manage debt?  The answer…it might.  

It really all depends on the situation.  Here are a couple of items to consider:

  • For example, if there is a program that can aggregate all of your credit debt into one payment plan, it is important to look at all of the facts.  Not only should the interest rate and the monthly payment be lower, but also the term (or the number of payments you’ll make).  If your payment is lowered only because you will now be paying for ten years longer than the original plan, that might not be your best option. 
  • Another example is with student loans.  Look at the interest rates associated with these loans.  It might surprise you how high they actually are (especially if you have unsubsidized loans and/or graduate school loans).  

      There are numerous things to consider when dealing with student loans, here’s a couple:

(a) Federal student loan consolidation where you apply to have all loans together with a Federal loan service provider with an interest rate based on the weighted average of your previous loan rates.  

(b) Student loan refinancing that replaces your existing loans with one new loan with an interest rate based on prevailing rates.  There are online lenders like SoFi, Elfi, etc. or traditional banks, like Citizens.  

(c) If you have equity in the house you own, you might be able to pay off your student loans by taking out a Home Equity Loan, generally at a lower rate.

Here’s a student loan calculator you can use from  FinAid calculator

Manage Debt – 5 Steps to Take:

  1. Make a list with all of your debt, include monthly payment and interest rate.
  2. Decide whether consolidating or refinancing some of your debt is a good idea (remember look for lower payments AND an equal or lower term).
  3. Look at your monthly budget to decide on an appropriate extra payment you can make each month.  Consider cutting back your other expenses by only spending money on essential expenses.  Hard to do, yes, but this will help you to pay more each month towards your debt principal.
  4. Target putting your extra monthly payments to: (a) bad debt first and (b) debt with the highest interest rate.
  5. A CERTIFIED FINANCIAL PLANNER™ professional is a good resource to help with budgeting, cash flow and debt management: Contact Us

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