Debt can be a major snag in achieving your financial goals– a minor issue of not paying off credit cards on time can quickly lead to a debt snowball! Debt can be used as a tool to help you achieve your goals, or it can become a weight that holds you back. When used properly, debt can be additive to your financial plan and understanding debt is the first step to managing it.
Different kinds of debt…
Debt which helps build wealth – such as a mortgage– is considered by financial institutions as “good debt”. As you pay your mortgage each month the amount of equity you own in your home will increase, and your net worth (a measurement of financial health) will go up.
Debt which is used to fund consumption – such as credit cards, student loans, car loans/leases – is considered a barrier to achieving your financial goals. This “bad debt” usually comes with high interest rates and, if left unmanaged, can be trouble. If you have credit card debt, you’re not alone – 48% of Americans hold credit card debt1.
How much debt?
I believe a good rule of thumb is for homeowners to keep their debt-to-income ratio below 35%. Renters should strive to stay below 20%. Staying within these guidelines will ensure that your debt stays manageable within your income and will help keep your credit score in check.
A long-term goal for debt is to be completely debt free by retirement– if you budget and spend wisely, you will be well on your way to achieving it!
Facing debt – make a plan
If you are carrying any bad debt, it’s time to face the music and make a plan. To build your plan to rid yourself of debt, give the “snowball" method a try.
1. Create a list of each debt, the amount you owe, the interest rate, and current monthly minimum payment.
2. If you have multiple accounts, consider consolidating into a single card or loan that has a lower interest rate than you are currently paying.
3. Determine the amount in your budget you will allocate to debt payments.
4. Prioritize paying down the debt with the highest interest rates first – not the total amount owed.
Debt plays an important role in our financial picture over the course of our lifetime. Build a budget, consolidate those open balances for a lower interest rate, make a plan to pay it off and stick with it! If you need any help or have questions about debt – ask our team!
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