Debts are Part of Life
Do not worry. Being debt-free is a great thing, but for most of us, the reality is different. Few people can give cash for a home, a car, or a college education. Still, it’s sensible to understand your debt and manage it properly.
Not all Debt is Bad
You require some credit history to qualify for a loan when you need one.
“Most of us are programmed to feel guilty when we owe money. It doesn’t matter if you owe a person, a bank, or a credit card company. The key is determining the level of debt that’s right for you,” explains Heather Winston, Associate Director of Financial Planning and Counseling at Principal.
Winston offers some rules of thumb:
- 28% of income before taxes
- It is the maximum amount of debt for your home (principal, interest, taxes, and insurance)
- 36% of income before taxes
- It is the maximum amount of all debts, including your home
- It is the maximum amount of all debts, including your home
You are Not the Only One
In a present survey, we asked consumers if they were making any economic changes due to COVID-19. 21% said they were going to pay off their debt*.
Three ways to strike a balance:
Know what you owe
It’s like keeping track of everything you eat when trying to get healthier. You write it down so you know where you are in the process.
In the case of debts, write down the balance, the interest rate, and the minimum payment. Please enter the data in our debt management worksheet (PDF).
Reduce the balance
Rank your debts according to size or interest rate. Then, analyze how you are going to deal with them.
Snowball Method: First, focus on paying off the account with the lowest balance. Continue to make the minimum payment on other debts. Once you eliminate that first debt, move on to the next debt with the most insufficient balance. It could be the correct method if you are motivated to make more minor credits disappear.
Highest Interest Rate Method: Focus on debts with the highest interest rates first. Try to pay off the next one with the highest interest rate when you pay off one. Of course, you continue to make the minimum payment for the other debts. If you want to pay the minimum over the life of your loans, this could be the proper method for you.
“When you pay off high-interest debt, you generally gain more long-term purchasing power,” says Winston. “But at the end of the day, do what works well for you. The key is that no matter which technique you choose, choose one and stay focused on it.”
When you pay off high-interest debt, you generally gain more long-term purchasing power.”
-Heather Winston, Associate Director of Financial Planning and Counseling
Manage your debts
Continue managing your debt as part of your overall financial plan.
Set up regular automatic payments. Late payments can hurt your credit, and you could be penalized. Automatic payment can be your friend in this regard.
To pay off debt faster, cut expenses from your budget or increase your income.
Suppose you hope to finance future expenses (buying a house next year or paying a deductible because you’re having a baby) and factor those expenses into your overall financial plan. Apply for loans intelligently and think very well before acquiring a debt. Read “Five questions to ask yourself before taking on debt.”
For credit card debt, try negotiating for lower interest rates. Ask for a lower interest rate, and you might get it. Or consider transferring your credit card balance to one that offers zero interest for a set period. Make sure you read the fine print. It is necessary to be aware of when the promotional period ends.
Refinance. You could save money, especially now that interest rates are so low. Or you can consolidate your debts and thus make a single monthly payment. Check the terms and conditions; there may be costs in the process.
Know Your Credit Score
Don’t forget about your credit score. Please get to know it and recheck it every year. The FTC has the information you can trust, including links to accessing your free annual credit report.
Having a lot of debt, especially high credit card debt, could affect your credit score. High credit scores typically allow loans to be approved more quickly. Of course, paying off your loan balance helps.
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