You can figure out how to manage debt, including paying off the debt you have, to help reach your financial goals.
Having no debt is great. But for most people, it’s unrealistic. For example, few can pay cash to buy a home or cover a college education.
But debt isn’t always bad. Paying your bills on time or paying off credit card balances monthly are two ways to manage debt and help build a positive credit history. That, in turn, may help improve your credit score, which means you may qualify for a lower interest rate on loans, for example.
“Many of us are hardwired to harbor guilt when we owe money,” says Heather Winston, director of individual solutions at Principal®. “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.”
How can you figure out how much debt works for you, how can you pay off any debt you have, and how can you manage the debt you might need in the future?
How much debt do you have?
Your first step is to be honest with yourself about where you stand. Make a list: Write down the balance of everything you owe. Also include the interest rate, term (if known), and minimum payment. Record those details on our debt management worksheet (PDF).
How much debt is it OK to have?
It varies from person to person, says Winston, but some rules of thumb:
- 28% of monthly pre-tax income: Maximum mortgage payment (principal, interest, taxes, and insurance)
- 36% of monthly pre-tax income: Maximum fixed debt payments (mortgage, car loan, student loans, etc.)
Use our debt-to-income calculator below to calculate your monthly ratio.
Create a plan to pay down your debt.
Most people use one of two methods to pay off existing debt.
- Snowball method: This debt payoff method has you tackle the smallest balance you owe first. Put as much as your budget allows toward that total and pay the minimum due on other debts. Once that first balance is paid off, work on the next debt with the next lowest balance. This might be the right method if you’re motivated by seeing smaller balances disappear.
- Avalanche method: This second debt payoff method suggests you focus on the debt with the highest interest rate while making minimum payments on other debt. Once you pay that high-interest debt off, you move to the debt with the next highest interest rate. If you want to pay less over the life of your loans, this might be the method for you.
“Ultimately, do what works best for you,” Winston says. “Pick one and stay focused on it.”
Choose the ongoing debt management strategies that work for you.
If taking on debt helps you achieve your big-ticket financial goals such as buying a home, figuring out how to manage that debt (and other bills you may incur) is worth your time. Some ideas include:
- Lean into auto pay. Late payments on any bill, from loans to utilities, ding your credit score and may end up costing you penalties, too.
- Pay more when you can. That doesn’t mean every month. But when you have extra, consider putting that toward debt.
- Carefully consider new debt. What are your plans in a year, five years, or ten years? The debt obligations you take on today impact your overall financial goals. (Five key debt management questions can help.)
- Consolidate debt. This may be useful for high-interest rate debt—if you can find a way to consolidate what you owe on more favorable terms. But review the details carefully, so you’re not caught paying fees or penalties you didn’t expect.
How do your debt management plans work with your retirement plans? As you’re setting a budget, think both about paying off debt and boosting your retirement. Log in to your Principal account to assess your savings rate. Don’t have an employer-sponsored retirement account? We can help you set up your own retirement savings in an IRA or Roth IRA account.
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.