Managing debt: 3 ways to find the right balance

Part of our build your own financial plan series

Photo of someone checking out and paying for a purchase.

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, CFP®, assistant director of financial advice and planning at Principal®.

Winston offers some rules of thumb:

  • Try not to carry more than 28% of your pre-tax income in debt on your home (principal, interest, taxes, and insurance).
  • Aim to have no more than 36% of your pre-tax income allotted for all debt, including housing.

You're not alone.

We asked millennials* about their financial resolutions for 2019. Top answers? Save more and reduce spending. But debt management was on their minds, too.

  • 32% said pay off credit card debt
  • 15% said pay off student loan 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, of course. Once the first is paid, move onto 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.

“I advocate for paying your higher interest rate first. It generally gives you more long-term purchasing power,” Winston says. “But ultimately, you should do what works best for you. The key is that no matter which method you choose, pick one and stay focused on it.”

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 0 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. Or consolidate debt so you make one payment. Just check the terms—there may be fees in the process.

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 understanding your credit report and score.

Next steps:

* Principal, consumer holiday spending and 2019 outlook (PDF): “Which of the following, if any, do you intend to make as financial New Year’s resolutions in 2019? Select all that apply.” December 2018

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.