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Manage that Debt!

Debt freaking sucks. It’s financially stressful, can be debilitating, AND… for the average person it is necessary. It’s a catch 22. A double-edged sword. And it’s something almost everyone has to deal with in their life. This is why debt management is crucial for mitigating financial stress because of debt.

What is debt management?

In context to this blog, I think of debt management as deciding between going into debt versus avoiding debt. This means thinking about why the debt is necessary, if it’s affordable, if it interferes with other debts, you are paying down, and if you should go into debt at all. Since most debts have built-in repayment plans, I don’t consider following the payment plans part of debt management.

With all that in mind… let’s talk about debt management.

When is it a good idea to go into debt?

I firmly believe that there are times it is a good idea to go into debt. Don’t write me off. I’m not crazy, I promise. My experience with debt is that it’s inherently “good” when it has more pros than cons. Good debt, in my mind, falls into three categories:

  • The debt is affordable, not financially strenuous, and will help your credit score. To me these are minor debts. Like financing a $2,000 furniture purchase on one of those fun “Buy this thing, have 24 monthly payments, same as cash, no money down, and no interest” deals where the monthly payment is reasonable, and the interest is low or non-existent if you pay it off in time.

  • The debt prevents you from decimating your savings account or paycheck. To me these are major debts that we probably can’t avoid and would have a less financially stressful life budgeting around monthly payments. My brain immediately goes to purchasing a car or a house. These are things we could save up for over years and buy with cash outright later on in life, but I would much rather pay off a debt over time to have them immediately.

  • The debt covers an emergency that cannot be avoided. To me these are like medical debts. Or your water tank broke and flooded your house and you need extra money to cover the repairs. While we hope to have money aside for this we can’t account for everything. And another unfortunate reality is that insurance companies are more concerned about their shareholders than their customers. Deductibles are crazy and a lot of the time you’re still required to shell out huge amounts of cash in emergency situations.

My opinion: Emergency situations are unfortunate and unavoidable. I never try to assess emergency debt from a pros versus cons perspective, rather I figure out how to make it work regardless.

For the rest of this blog, I will be focusing on the first two “good debt” scenarios.

Can you afford the debt?

Debt is only good if it is reasonable, affordable, and overall beneficial to you. Whatever debt you willingly take on is your responsibility. That’s your bed and you got to lie in it. I want to offer you some of my best practices I use to ensure I’m not suffocated by debt.

This first method I learned from a mortgage broker who explained to me how to see if I could afford the anticipated mortgage payments. It’s the debt-to-income ratio. While the banks don’t do it quite like this, I’ve adapted the debt-to-income ratio test as my personal modus operandi in assessing my ability to go into debt. Instead of looking at just debt, I expand it to all my necessary expenses. As discussed in my budgeting blog, you want to aim to only have about 50% of your income go to your required monthly expenses. This includes all debts.

For my adapted formula, all you do is calculate your personal, non-negotiable monthly expenses. This list would be things you are not willing to give up after taking on this new debt. For me it’s my mortgage payment, my other loan and credit card payments, and my monthly bills as an example. For you it might be your monthly savings amount, getting your hair done, and your credit cards. Who cares what the list is? Just figure out your non-negotiables. 

Once you have that total you take that amount and divide it by your average monthly income. To get your average monthly income just take your average yearly salary and divide it by 12; now you’re ready to calculate your debt-to-income ratio.

Ratio = Non-negotiable expense / monthly income

If the ratio is over 0.5, you may be in a risky area taking on more debt as that would have you exceeding the 50% recommended monthly expense category. If it exceeds 0.8, I would strongly advise to not go into debt as you would have over 80% of your income as non-negotiable and leave only 20% for everything else including unexpected emergencies.

With this information you will be able to make informed decisions on your budget, how you can modify it to accommodate this debt, and if this debt is worth it.

The second method I have adopted is before I accept any new debt I sit down and create a debt strategy. This may be my Type A personality coming out, but it has helped me manage financial stress, so it’s a win in my book.

Step 1 in my strategy is to look at my budget, my flexible income, and ask myself a few questions: 

  • Do I want to pay it according to the term agreements? For example, if I take out a four-year loan with once-a-month payments is my plan to simply follow the payment schedule given by the bank?

  • Do I want to build an aggressive paydown strategy? For example, if I take out a four-year loan with once-a-month payments, do I want to double up on payments where every paycheck I make a full monthly payment to pay it off faster? 

  • Do I want to allocate extra funds to paying off my debt? For example, if I take out a four-year loan with once-a-month payments, do I want to make additional principal payments with bonus income like my tax returns to pay it off faster? 

Step 2 in my strategy is to figure out the best way to pay off the debt based on my current budget, other debt plans I may have in place, and my overall debt goals. This should be guided by all the information formulated in Step 1 as well as your existing personal debt goals and payment plans you’ve already set up in your budget. I personally want to be entirely debt free by the time I’m 50, as a debt goal example. I don’t know how else to explain this, so I really hope it makes sense!

Step 3 in my strategy is to actually update my budget and write down my plans as if I already have the debt. This way I can visually see the impact of the debt on my current financial situation.

I do all of this before even accepting the debt, to ensure I will not feel stressed with the new debt. If I’m comfortable with the outcome, then I feel confident accepting the responsibility of the debt.

The third method I have recently started doing, is to legitimately and seriously ask myself: “Do I have too much debt right now to even think about this?” If you’re anything like me, you’re neurotic to a fault and love to control everything. Having too many debt plans to manage is suffocating for me. So even if I could go into debt, I may not want to for some time just for peace of mind.

Other methods have come in and out of my process to see if I want to go into debt so I can give them a fun little shout out.

  • How long can I go without the purchase that would put me into debt? This is a question I usually add into my debt strategy if the purchase is more of a want than a need.

  • Do I need this item/thing I’m using the debt for? This is my way of challenging myself to determine if it’s something I can wait to save up for. Or is it something I should go into debt for?

  • As a follow up to the previous one, I would then run through the pros & cons of financing versus saving for the sake of the purchase/item/event that I am considering.

These are my tried-and-true debt management methods. If you take anything from this blog, I hope it’s a newfound appreciation for debt planning and management.

Go forth, my readers, and be debt managing machines!

Author’s note: This is a not-blog blog. There will be no long-winded introductions, no weird backstories from childhood memories, and absolutely no pointless paragraphs of text about things you’d rather have a “skip to the important stuff” button to bypass.

I hope my posts are helpful. I try to break these things down in a way that is easy to read and understand. I appreciate any feedback on how to improve, so feel free to leave a comment below. If you are simply enjoying the content, I’d love to hear about that as well!

Disclosure: I am not a licensed financial advisor. I have an accounting degree and am a business major with a certification in finance, but I am not a legal expert. These posts come from my personal experience, learning through trial and error, working in the banking industry for nearly a decade, and seeing the fruitfulness of this advice in my own life.

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