Debt. No one wants it, but most people have some. Poor debt management can drag you down financially and emotionally and feel like a big obstacle, hovering like a black cloud over your life. Debt doesn’t have to be all doom and gloom, though. It can be effectively managed, no matter how much of it you may have. Here’s what you need to know about your debt so you can manage it and not let it manage you.
Debt as a tool
Some say that no debt is good debt, and in an ideal world, that’s great. In the real world, however, it’s often necessary, and, in some cases, taking on debt can pay off. “Debt should be considered a tool when used appropriately,” says Joseph Medema, retail branch manager at American Bank & Trust’s River Centre location in Sioux Falls, “A reasonable amount of debt can help individuals acquire an asset that can gain equity, both in principal pay down and appreciation.” For example, home ownership often isn’t possible without taking out a mortgage, but over time a house will often increase in value. Businesses may also need to utilize debt in order to make investments in things like buildings or equipment, which provide a return that wouldn’t be achievable without that debt financing. Such debt-financed investments can often increase cash flow and bolster net worth.
As a general rule, Medema says that when taking on debt for investment purposes, one should carefully consider the rate of return on the investment versus interest rate on the debt. Also, decide whether or not the risk and cash flow associated with the investment warrants the debt service requirements of the new debt. A trusted bank or financial advisor can help you make those calls.
Debt can’t be ignored
The most common mistake people make with debt management is ignoring it, Medema says. The problem is that not only will that not make your debt disappear, but your debt will likely continue growing until you put a plan in place. Then there are debt relapses. Many people stick to a budget for a period of time and get themselves out of excess debt, which is great. All too soon, however, many revert to their same old spending habits and quickly find themselves back in debt. “As challenging as it may be, creating a budget and sticking to it is not only empowering, it also takes away many unknowns that create financial stress,” Medema says. “The short-term sacrifice of living modestly in order to get your financial situation in order is far better than the continued stress and burden of too much debt.”
Steps to eliminate debt
It can feel overwhelming at first, but putting a plan in place and sticking to some basic rules can help the process feel more manageable. Medema suggests the following:
- Stop creating more debt.
- When possible, increase your monthly payments.
- In general, strive to keep your debt ratio lower than 40%, meaning no more than 40% of your monthly income is used to pay debt.
- Know which debts have variable rates and how rate increases may affect your monthly payments.
- Pick one debt, and pay it off first. In most cases, this should be the one with the highest interest rate.
- Investigate your debt consolidation options. You may be able to lower your interest rate, payments, or both by consolidating your debts.
- Adjust your lifestyle as necessary. Are there things you can live without for a while? Is there something you might be able to sell to pay off debt? Can you pull in any extra income by getting a side job?
Help is available
If you need help creating a budget and managing your debt, an experienced banker or financial advisor can help. “For most bankers, this is the most rewarding part of the job,” Medema says. “Not only will we be able to offer insight, but we can also put you in touch with the best resources to pursue in order to gain and maintain strong financial health.” Every financial situation is unique, and there are no cookie-cutter answers for debt management. The best thing you can do is to seek out solutions from trusted professionals who can help you put a realistic debt management plan in place. For more information on how to manage your debt, contact American Bank & Trust or a financial advisor.