Debt is money you owe to another person or business. If you use loans, credit cards or behind on bills, that is debt. Debt can be complicated because sometimes you hear the terms good debt vs. bad debt. When those terms are used it is generally described as “good debt” being something that can help you reach your goals or make investments such as borrowing to further education, buy transportation or a home. Some consider other types of loans, credit cards or pawn loans “bad debt”. However, you look at it, debt always carries risk. When you owe money to someone else it also costs you money in the form of interest.
Typically, home loans and student loan debt have a smaller interest rate. However, credit cards, car loans, payday loans or auto title loans usually have much high interest rates that make it difficult to pay off the debt and carry significantly more risk. Avoiding these types of debt will be important. Alternatives to short term loans could be to negotiate for more time to pay, make sure this is a need and not a want, use lower interest rate credit cards or loans from a bank or credit union, use your own emergency fund savings, borrow from a friend or family member.
Determining your debt to income can also help you do a check on the overall health of your finances. To calculate your debt to income ratio, add your total monthly debt payment together then divide by your gross monthly income. Multiply by 100 to calculate your current debt to income ratio. Consider maintaining a debt to income ratio for all debts of 36% or less.
If that percentage is higher than 36% or higher than you would like it to be consider using a debt action plan to reduce your debt. There are a couple of strategies you can use. One method is listing your smallest debt to your largest debt and pay off the smallest ones first. The pro to this is it can be very motivating to see debt quickly disappear. The con to this method is if the large debts have large interest rates then you are paying a lot in interest. The second method is to pay highest interest rate debt first and end with your lowest interest rate. This will save you money but it also might be a long and daunting process. Since finances have a big emotional part to them staying motivated might be the key!
If you are needing help with debt you can contact a credit counselor at consumerfinance.gov
Whatever debt you have consider paying it off and creating an emergency fund so you can be your own bank rather than relying on debt. It might just lower your stress level!
Monique Koerner is the Family and Community Wellness Agent with K-State Research and Extension – Cottonwood District. You may reach her at: 785-628-9430 or [email protected]. K-State Research & Extension is an equal opportunity provider and employer.