How to Manage Debt

Borrowing money can help you get an education, buy a car, or finance a home. It also helps you earn the trust of the financial community. That trust can pay great dividends in your life—if you manage your debt responsibly.

Understanding How Much Debt Is Manageable for You

One cornerstone of responsible debt management is understanding what you can afford to pay for debt.

A first step toward this understanding is to add up your monthly income from all sources and then deduct essential expenses, such as food, housing, car insurance, and medical care. The amount left over is what is available for saving, for "discretionary" spending (such as movies, restaurants, cell phones, traveling), and for debt payments. For more help with budgeting see CollegeData's article Stay Afloat Financially at College.

The next step is to decide how much you want to save, how much you want available to spend freely, and how much you want—or can afford—to spend on debt payments every month. A simple spreadsheet or online debt calculator can help you experiment with debt amounts, payment amounts, and time required to pay off a debt.

If you already have debts, another useful exercise is to take a closer look at what you owe. Write down amounts owed, monthly debt payments, and interest rates. What you see might be an eye-opener. For example, you might see that one of your debts has a higher interest rate and decide to pay it down more quickly than others to reduce your borrowing costs.

Your Readiness to Qualify for Credit

You are not alone in your quest to understand how much debt you can manage. When banks or other creditors consider whether to offer you credit, they evaluate your risk as a borrower. They rely on information from you, your employer, your bank, and your credit reports to assess your credit worthiness in four areas:

If you are just starting out as a borrower, and don't have an extensive credit history, it might make sense to take steps to reduce your risk to lenders. Such steps include paying bills and making debt payments on time, putting money into a savings account, and maintaining a consistent source of income.

If you have never been issued credit, some lenders may evaluate your creditworthiness based on factors such as proof that you pay rent, utility, and phone bills on time, or that you make regular deposits to a savings or checking account. You could also ask another person, such as a parent, to cosign a loan. This gives you an opportunity to make payments on time and build your credit history. At the same time, the lender's risk is reduced because it can rely on the good credit of the cosigner. (The cosigner would have to pay what you owe if you didn't make the payments.)

Understanding the Costs
of Borrowing or Using Credit

Yet another cornerstone of effective debt management is understanding that credit is not free—there is a cost. Lenders state the following charges in a clear and uniform manner so you can easily see the cost of borrowing money.

Understanding Forms of Credit

Finally, responsible borrowers understand that most borrowing comes in one of two forms:

A Few Words About Student Loan Repayment

Student loans are an essential part of financing college for many students. After you leave school, however, it is time to pay back those loans.

Federal loans (and many private educational loans) offer several loan repayment options, including payments that are the same every month or gradually increase over time as your income grows. The standard repayment plan is a fixed monthly payment for up to 10 years. Other repayment plans offer terms of up to 25–30 years, depending upon the amount borrowed.

For federal loans, you are allowed a six-month grace period before payments begin—and you can get up to three years of loan deferment based on your income, student status, and other factors. Private loans may offer similar options. Be aware that the consequences of defaulting on a federal student loan are severe. Not even bankruptcy can let you off the hook.

Here's to Your Financial Health

Managing your debt is a little like managing a healthy diet. If you eat too much of the wrong kind of food, you risk your health. Eat too little of the right kind of food, and you risk lacking the strength to take important steps in your future.

Information in this article is of a general nature. It is provided by COLLEGEdata for educational purposes only and may not apply to you or your situation. Please consult a financial or legal advisor before acting on such information. COLLEGEdata is a service of 1st Financial Bank USA, a provider of financial services.