UFCU SPONSORED CONTENT — At some point in your life, you will probably borrow money and take on debt—and that’s OK. Some debt, like buying a home, is considered “good debt” because it’s an investment that has the potential to increase in value over time. Whether you have a mortgage, student loan, car loan, or credit card debt, there are proven strategies to manage it all and pay it off.
First, know how much debt is too much debt.
Regardless of the type of debt you have, make sure your debt-to-income (DTI) ratio is considered safe by lenders. The ideal DTI is 30% or less of your monthly income. To figure out your number, total up all the monthly payments you have for loans and credit cards. Divide that number by your monthly income before taxes are taken out. Then, multiply by 100. That’s your DTI ratio. For example, a person with $1,500 total debt payments and a $5,000 monthly income has a DTI of 30%, which is considered a manageable ratio.
Next, determine how much you can pay off each month.
A good method to budget your bills and obligations is the 50-30-20 rule. This rule suggests:
- 50% of your monthly income should go toward needs, like rent, utilities, groceries, and gasoline.
- 30% is set aside for wants, like dining out and concert tickets.
- 20% should go toward debt and savings.
For example, a person with a $5,000 monthly income can comfortably budget $2,500 for needs, $1,500 for wants, and $1,000 for savings and debt payments.
Keep in mind that some debt can overlap with the “needs” category, like a mortgage. When considering how much you can pay, you should always make at least the minimum payment on all debts. If there aren’t enough funds using the 50-30-20 rule, lower the “want” category to less than 30%. Use any additional money in the 20% category to pay down debt or add to your savings.
Finally, pick your payment method: avalanche or snowball.
The avalanche method is to pay your high-interest-rate debts first. This method reduces the overall interest you will pay.
- Start by listing your debts from the highest interest rate to the lowest. You can find your interest rate, or APR, on your monthly statement.
- Pay the minimum amount owed on all of them, and focus any extra money you can spare on the debt with the highest interest rate.
- As you zero out one debt, focus those funds on the next higher interest rate on your list. Repeat until you’ve taken care of them all.
The snowball method is to start out small to make big gains. This method can be quite motivating.
- Start by listing your debts by the smallest balance to the largest balance owed.
- Continue making all the minimum payments, and focus any extra money on paying off the debt with the smallest balance first.
- After you pay off a loan, move your focus to the next smallest balance, building momentum like a snowball rolling downhill.
When in doubt, talk it out with a financial professional to learn the best available options for your situation.
If you’re looking for additional financial tips and tools to better plan, spend, save, and borrow, check out PlanU by UFCU. You’ll find options that range from talking with a financial health expert to creating a personalized resource center to meet your needs.