Debt refers to money borrowed by one party from any other party to serve financial needs. Debt is a financial liability involving an agreement between the borrower and the lender to repay the principal amount and predetermined interest rates over a specified period. Debt can take many forms, such as loans, corporate bonds, mortgages, government bonds, etc.
Debt can be stressful for individuals, companies, or other organizations because unmanageable debts can lead them to financial instability. Debt management has become imperative because the average American carries a debt of 21,800 USD, according to money.com. Debt can be good or bad depending on the purpose for which it is incurred. Being debt-free is ideal for everyone, but sometimes, debt can be taken to finance projects or other purposes
What is a Good Debt?
Debt can be considered as Good debt if created to generate income, help build wealth, or for the investment motive. Incurring debt in some instances, like paying education expenses, funding a business, or buying assets like a home, can help build a solid financial base. In short, if a debt can increase net worth, it is called a Good debt.
What is a Bad Debt?
A debt is considered Bad debt if it is incurred to finance or purchase a depreciating asset. This debt does not help create wealth and bears high-interest rates. Some Bad debt includes debt taken to go on vacations, buy clothes and consumables, buy cars, etc.
How to Manage Debt?
It is essential to manage debt once it is incurred. Here are some critical strategies to manage debt.
Assessing Debt
The first step to debt management is knowing how much you owe. Make a list of the total amount you owe, the interest rate, the minimum monthly payment, and the due date of each debt. This will help you understand your financial responsibilities and help you determine which debts you must tackle first. Take inventory of all your debts, including credit cards, loans, and other balances.
Creating Budget
After assessing debt, another strategy for debt management is creating a budget plan. Track your monthly income and identify the areas where there is a need to cut down unnecessary expenses. So, set a budget for spending on necessities and put aside some amount to pay off the debt. Budgeting your costs gives a clear picture of your expenses and, hence, can make you able to pay your debts quickly.
Use the Debt Avalanche Method
It is a debt management strategy to pay off debts with higher interest rates. The debt avalanche approach refers to making the minimum payment on each outstanding and using the extra money to pay the bill at the highest interest rate. Using the debt avalanche method allows you to save as much as possible on your interest payments.
Use the Snowball Method
This debt management strategy is like tackling the most straightforward job first. The snowball strategy refers to paying off the debts with lower interest rates first and vice versa.
Note: Both the debt avalanche method and snowball have pros and cons depending on one’s financial circumstances. The debt avalanche method can be better in terms of saving money, while some find the snowball method better because it motivates the debtors to pay off the debt quickly.
Debt Consolidation
Having multiple debts with different high-interest rates can be challenging to manage or repay; consolidating these loans into a single loan with lower interest rates can make paying off these debts easier and more manageable. It is a debt management strategy that involves incurring a new loan to pay off current debts, leaving you to focus on one single debt payment (the new one).
Debt Consolidation is a three-step Process
a. The first step is taking a new loan
b. Use this new loan to pay off the current debts
c. Then, pay off the new loans.
Avail Opportunities to Earn Extra Income
Explore new ways to earn income, such as starting a part-time job or any other job, as per your skill, to increase your earnings. Use the money earned to pay off the debts and save money in the long run. Debt management through this strategy needs a balanced approach. Today, you can earn part-time income through freelancing, which includes writing, graphic design, or programming. Or you can earn through blogging or vlogging. Regardless of which method you choose, prioritizing debt repayment is essential to effectively manage your financial obligations and work towards long-term financial stability
Cut Down Unnecessary Expenses
Cutting down on expenses is another way to pay the debt quickly. Point out the areas where you can reduce spending, such as unnecessary items. By carefully examining each expense, an individual can identify expenses that can be reduced, such as reducing the frequency of eating out, subscribing to cheaper services, and finding ways to go. or to save fuel costs. Additionally, negotiating lower rates with your provider or finding more affordable ways to pay basic expenses like utilities can lower your monthly bill.
Building an Emergency Fund
Building an emergency fund is also very important for debt management. Saving money for precautionary purposes can prevent someone from going further into debt. Emergency funds provide a financial safety net, allowing individuals to cover unexpected expenses without additional debt. To build an emergency fund while managing debt, it is recommended to start small and gradually increase your savings over time. This can be done by setting aside a portion of each paycheck for an emergency fund.
Negotiate with Creditors
If you are facing financial problems, always seek help from your creditors. Many lenders are willing to work with borrowers needing help repaying their loans. You can negotiate a lower rate, lower down payment, or longer repayment terms. Be honest about your financial situation and provide the necessary information to support your claim. Remember, if you work with your debtors and are willing to cooperate, they will be more flexible.
Bottom Line
Having debt can threaten a person’s or an organization’s financial stability. Unmanageable debts can especially be harmful to their financial health. It is essential to manage debt strategically once it is incurred to maintain economic stability. So, the strategies mentioned above for debt management can be used to avoid unwanted debt.
