Part of our build your own financial plan series
Managing debt: 3 ways to find the right balance
Debt. It’s a fact of life.
Having no debt is great, but it’s unrealistic for most. And that’s OK. Few people can pay cash to buy a home, car, or college education. Still, it’s wise to understand the debt you have and manage it appropriately.
Not all debt is bad.
In fact, you need some type of credit history to qualify for a loan when you really need it.
“Many of us are hardwired to harbor guilt when we owe money. It doesn’t matter whether it’s to an individual, a mortgage loan, or a credit card company. The key is to figure out the right level of debt for you,” says Heather Winston, assistant director of financial advice and planning at Principal®.
Winston offers some rules of thumb:
28% of pre-tax income
Maximum amount of debt on your home (principal, interest, taxes, and insurance)
36% of pre-tax income
Maximum amount of all debt, including your housing
You're not alone.
In a recent survey, we asked consumers if they were making any financial changes as a result of COVID-19, and 21% said they were going to pay down debt.*
Ways to find the right balance
1. Know what you owe.
It’s like writing down everything you eat when you’re trying to get healthy. You do it to know where you stand.
For debt, write down the balance, the interest rate, and the minimum payment. Log it on our debt management worksheet (PDF).
2. Pay it down.
Rank your debts in order of size or interest rate. Then decide how to tackle it.
Snowball method: Focus on paying down the account with the smallest balance first. Keep making minimum payments on other debts. Once the first is paid, move on to the next debt with the lowest balance. This might be the right method if you’re motivated by seeing smaller balances disappear.
Higher interest rate method: Focus on debt with the highest interest rate first. Once you pay one, work on the one with the next highest interest rate. Continue making minimum payments on other debt. If you want to pay less over the life of your loans, this might be the method for you.
“When you pay off a higher interest rate debt, it generally gives you more long-term purchasing power,” Winston says. “But ultimately, do what works best for you. The key is that no matter which method you choose, pick one and stay focused on it.”
When you pay off a higher interest rate debt, it generally gives you more long-term purchasing power.”
Heather Winston, assistant director of financial advice and planning
3. Manage your debt.
Continue to manage your debt as part of your overall financial plan.
- Set up regular automatic payments. Paying late could hurt your credit, plus you may get hit with a penalty. Autopay can be your friend.
- To pay debt faster, cut expenses from your budget or boost your income.
- Borrow smart and think hard before you take on debt. Read “5 questions to ask before you take on debt.” If you expect to finance future expenses (to buy a home next year or pay a deductible because you’re having a baby), take that into account in your overall financial plan.
- For credit card debt, negotiate lower interest rates. Call for a lower rate and you just might get one. Or consider a good balance-transfer credit card that allows you to move debt to a card with zero interest for a period of time. Read the fine print, though. You don’t want to be caught unaware when the promotion period ends.
- Refinance. You could save money, especially since interest rates are so low right now. Or consolidate debt so you make one payment. Just check the terms—there may be fees in the process.
Interested in learning more about managing debt?
“Budgeting for a home: how much can you afford?”
“Pay off debt or save for retirement? 5 steps to balance both”
Know your credit score.
Don’t forget about your credit score. Know it and recheck it every year. Here’s how to request your free copy. (It’s the only website authorized by the federal government.)
Paying your loan balances helps, of course. Carrying a lot of debt may affect your score, especially high credit card debt. Correct errors on your credit report as soon as you identify them. Higher scores typically mean easier loan approvals.
Learn more by reading “3 steps to understand your credit score and keep it healthy.”
Next steps:
- Managing debt is a key part of any financial plan. Ready to build your own plan? Here’s our step-by-step guide.
- Want to talk to a professional? We’ll help you find one near you.
* Principal Financial Group consumer pulse survey, March 2020.
Annualcreditreport.com is not an affiliate of any company of the Principal Financial Group. Link provided as a courtesy only.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.
Investment advisory products offered through Principal Advised Services, LLC. Principal Advised Services is a member of the Principal Financial Group®, Des Moines, IA 50392.
Insurance products from the Principal Financial Group® are issued by Principal National Life Insurance Company (except in New York), Principal Life Insurance Company and the companies available through the Preferred Product Network Inc. Securities and advisory products offered through Principal Securities, Inc., 800-247-1737, member SIPC. Principal National, Principal Life, Preferred Product Network and Principal Securities are members of the Principal Financial Group®, Des Moines, IA 50392.