Money Lesson 9 - Controlling Debt

Don’t let anyone ever convince you that debt is bad. The right kind of debt can help propel you forward. In fact, most people who become wealthy with the borrowed money. But, as we all know, too much of the wrong kind of debt can easily sink you. Statistic shows that Americans are stretching their credit to the max. The trend toward using credit cards to pay for regular expenses such as utility bills, grocery bills, gas, and fast food illustrates the increased dependency on credit. And credit cards are far from the only type of debt. Student loans, mortgages, IRS debts, and other indebtedness can leave you wondering how you can stay in control. In order to take charge, you'll need to keep a few of the following tips in mind and be ready to stick to a plan.

1. Track your spending

This doesn't have to be a big formal exercise. Just know how much income you make each month after taxes and then subtract all your fixed expenses, like housing, car payments, transportation, food, utilities and insurance. If you have debt, make sure debt repayment is factored into your expenses. This list will tell you how much you can afford to spend on discretionary items, such as clothes, travel, and entertainment. Then, start tracking how much you actually spend.

2. Know what you are really paying

Know what you are really paying. How much debt are you comfortable with carrying? If you are unsure, ask yourself how much interest you are wiling to pay each month. Then calculate how much debt you can have at that level of interest by taking the number you've come up with and dividing it by the decimal form of the interest rate you're paying. For example, if you would like to pay no more than $25 in interest each month and your interest rate is 12.9%, divide $25 by .129. (For 9.9%, the decimal form would be .099. Don't forget to put in the extra zero for single digit interest rates. ) You'll find you should carry no more than about $195 as a balance on your card each month to stay at this interest level.

3. Pay off your highest-rate debts first.

The key to getting out of debt efficiently is first to pay down the balances of loans or credit cards that charge the most interest while paying at least the minimum due on all your other debt. Once the high-interest debt is paid down, tackle the next highest, and so on.

4. Don't fall into the minimum trap.

If you just pay the minimum due on credit card bills, you'll barely cover the interest you owe, to say nothing of the principal. It will take you years to pay off your balance, and potentially you'll end up spending thousands of dollars more than the original amount you charged.

5. Watch what you borrow for

If you take out a $10,000 college loan at a 7 percent interest rate, and as a result boost your lifelong income by hundreds of thousands of dollars, you've received a big return on that debt. Homes are another good example. Say you get a mortgage at a 6.5 percent rate. Even if your home appreciates at just 5 percent a year, after many years you potentially could come out ahead.

Avoid or minimize the borrowing that can create "bad" debt. Expenses such as automobiles, appliances, vacations, restaurant meals and entertainment are fall into this category. There is nothing wrong with charging these expenses on credit cards -- but you should pay off the outstanding balance each month to avoid a finance charge and growing balances. At the very least, the items you are purchasing should last longer than the debt, even if the assets are depreciating in value.

6. Expect the unexpected

Build a cash cushion or emergency fund worth three months to six months of living expenses in case of an emergency. If you don't have an emergency fund, a broken furnace or damaged car can seriously upset your finances.

7. Get help as soon as you need it

If you have more debt than you can manage, get help before your debt breaks your back. There are reputable debt’s counseling agencies that may be able to consolidate your debt and assist you in better managing your finances. But beware of scams who will make you of you bad debt situation and suck more money from and make your debt situation even worse.

Money Lessons


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