How To Manage Your Debt

Managing your debt is important to your overall financial health. It will impact everything from your ability to get a home or auto loan, the interest rates you pay, your insurance premiums, and in some cases, even your employment opportunities.

You don’t have to get rid of your debt. In fact, you shouldn’t. Having a modest amount of debt relative to your total assets shows creditors that you are a responsible borrower. The key is to manage your debt.

During the past 17 years of managing my own debt and building what is considered an excellent credit score, here are my answers to common questions on debt management.

How do I start managing my debt?

Start by taking stock of the debt you have. Review all of your accounts and write down or create a spreadsheet of the type of account (credit card, mortgage, etc) the outstanding balance, the interest rate and monthly payment. Add up the total outstanding balance on each account to determine your total debt load. You should always be cognizant of your total debt load and how you are adding to it with each purchase you make.

Next, determine how much of that is installment debt and how much is revolving debt. An installment loan consists of a fixed loan amount that you pay down in monthly payments or even one lump sum (such as with a store credit appliance purchase). The rate can be fixed or variable. Common types of installment debt are home mortgages and car loans. Revolving debt, on the other hand, is like an open line of credit up to a specified amount, which is your credit limit. The most common type of revolving account is a credit card account. The exercise of creating a sketch of your current debt load is important to understanding how to tackle your debt.

Should I make additional mortgage payments?

Certain accounts should have priority over others when you decide which to pay down first.

Many people decide to make additional payments on their installment debt (mortgage, car and student loans) to try to pay it down, even when they carry credit card debt. During the current period of rampant “upside down mortgages” there is a fear-driven need by some to aggressively pay down a home loan to hasten the pace toward free and clear ownership.

It makes more financial sense, however, to pay down your credit cards, before making additional payments on installment debt. Credit cards carry the higher rates. Furthermore, carrying high credit card balances will hurt your credit score, especially if they are high when compared to your credit limit—something referred to as revolving utilization.

A home mortgage, on the other hand, often helps your credit score (unless you are significantly over –leveraged) because homeowners are considered stable. Finally, you can deduct the interest your pay on your mortgage as well as your student loan (subject to adjusted gross income limits). While you can’t deduct the interest on auto loans, the interest rate will most certainly be below the rate you are paying on your credit card. For these reasons, you should always pay off all credit card balances before making additional payments on any installment debt.

Once you pay off your credit cards, then you can start attacking your installment accounts, starting with your highest interest rate loan in which the interest payments are not tax-deductible.

The only exception to the above would be installment loans that are non-amortizing…so called interest-only. Then it would be wise to make additional payments that apply to principal reduction.

Which credit card do I pay down first?

Pay down the credit card account with the highest interest rate. This will have the biggest positive impact on your debt recovery. After setting aside your fixed amount obligations (your monthly amounts for rent, car, and other bills), begin an aggressive pay down plan on your highest interest rate account. Be sure to continue to pay at least the minimum on all of your other credit card accounts. Yet keep your main goal on paying down the highest rate account.

If the account with the highest interest rate also happens to have an outstanding balance that seems insurmountable, you may want to start with one of your smaller accounts. While this will not have as great of a financial return as tackling the card with the highest interest rate, some people feel a little encouragement by simply reducing the number of payments each month. While I still advocate for getting rid of the highest rate first, what is most important is that you get started on the path toward debt reduction and stay on it.

What if I can't make a payment?

Even if you are carrying a healthy debt load, the road to crippling debt can be a slippery slope. You may be current on your payments but are approaching a point where you can’t afford to pay one or more of your bills. If you are in this situation, be proactive and call the creditor in order to work out a payment plan before the bill is due. Do not wait for bills to pile up. Request that they refrain from reporting any delinquencies to the credit bureaus in exchange for setting up a payment plan that you stick to. 35% of your credit score is based on bill paying history. If you are already delinquent, still make that call to start a payment plan. Ask to speak with a supervisor or someone with authority. There’s no guarantee that you will get a favorable payment plan, but it never hurts to ask. Remember to be courteous and stay calm. You will increase your chances of being successful.

Regardless of whether you are currently deep in debt or fear you may fall deep into debt, take action now. The earlier you take control of your finances the more benefits you will reap in the future. If your debt load is huge and seems overwhelming, the most important move you can make is to get started and stay committed to paying it down.