Being in debt can feel overwhelming, as you don’t want to hurt your finances by facing growing interest charges and possible damage to your credit score. However, managing debt doesn’t have to be scary or confusing. There are several straightforward ways to tackle debt that can help you get on a better financial footing.
Check Out: 8 Steps To Take Now if You Owe Significant Interest on Student Loans
Learn More: 9 Things You Must Do To Grow Your Wealth in 2024
GOBankingRates spoke to Jung Seh, CFP, financial advisor at Bogart Wealth, to discover what advice she gives to clients with debt.
Also see five myths about debt that nobody should believe.
It’s Going Viral: Want to Retire Rich? Suze Orman Says You’re Missing This Key Money Move
Create a Budget
Budgeting helps you see where you stand with your finances. You expenses being too high could be part of why you accumulated debt in the first place.
“The first place I would start is to create a budget,” Seh said. “You’ve got to know how much money is coming in, what your variable expenses are and what your fixed expenses are.”
As part of this process, she suggested listing out all of your debts and seeing what you can afford in monthly payments to start paying off your debts. Perhaps adjusting some of your variable expenses, like dining out, for example, can mean putting more toward debt payments.
Read Next: 6 Ways To Lower Your Student Loan Debt Interest Rate
Consider Debt Rules of Thumb
In looking at your budget, it might not be possible to wipe out all your debt right away. But you should at least consider some general debt guidelines to make your finances more manageable.
“When thinking about debt, there’s some general rules of thumb. Housing debt, which includes principal, interest, taxes and insurance, or whatever you’re paying in rent, should ideally be less than 28% of your gross income. Total monthly debt should be less than 36% of your gross income, and consumer debt should be less than 20% of your gross income,” Seh said.
So if you’re seeing that your housing debt is above this benchmark, for example, perhaps you need to seriously consider moving or refinancing your mortgage if that can lower your monthly payment to a more tolerable level.
Pay Off High-Interest Debt First
While the general debt thresholds listed above can provide some guidance, you also want to look at the interest rates for different types of debt. Some low-interest debt, like some mortgages, could be tolerable, whereas high-interest debt, like credit card debt, should typically be your priority.
“If you have debt, another general rule of thumb is you want to pay the highest interest rate debt off first,” Seh said.
This applies primarily to consumer debt, she explained. “When you have a bunch of credit cards, what you want to do is you want to pay the minimum on the lowest-rate card and pay as much as you can on the highest-rate card,” Seh said.
Remember That Not All Debt Is Bad
It’s also important to remember that not all debt is bad debt. While some debt, like high-interest consumer debt, is likely best paid off as soon as possible, you may want to weigh your options when looking at lower-interest debt, like student loans and mortgages. “So, you want to make sure that you’re weighing the pros and cons of paying those off,” Seh said.
She explained that some clients want to be debt-free. But quickly trying to pay down all debt could hurt your long-term finances. For example, if you have a very low interest rate mortgage, rather than paying more than the minimum, you might be better off investing that extra amount and holding on to your mortgage debt.
“That could actually yield a better return,” Seh explained. “Having debts like carrying a mortgage can also increase your net worth and help your credit score.”
Keep Investing In Your Future
While it can be tempting to try to rid yourself of debt as fast as possible, it’s also important to keep investing for the future while paying down debt. “Especially in this type of environment that we’re in now, where we’re still in a higher interest rate environment, some may be tempted to decrease their retirement savings and pay off their debt first. But I would caution them against doing that,” Seh said.
If you hold off on retirement savings now, you could miss out on the power of compounding returns. Even if you catch up on contributions later, the results might not be the same due to the missed time.
“You want to make sure that you continue to pay yourself first for your future. Compounding interest is such a powerful tool. Time is something that you cannot make up,” she added.
Figuring out how much to invest for retirement versus how much debt to pay off comes back to budgeting. Typically, you want to invest at least 10% of your income for retirement, and building that as a fixed expense in your budget can help you see how much you have left for debt.
“When you’re creating your budget, you want to make sure that paying yourself is already included in that budget,” Seh said.
Be Careful About Using New Loans To Pay Off Existing Debt
While taking out a new loan to pay off existing debt can be tempting, such as if it enables you to obtain a lower rate, there are still risks to watch out for. Take a home equity line of credit, or HELOC, for instance. “An example of that is taking out a HELOC to pay off credit cards,” Seh said. “What you’re essentially doing is you’re securing your home to pay off unsecured loans. That can be risky if for some reason you cannot pay back the HELOC loan.”
Also, the lower rate can still lead to higher overall costs. “HELOC loans typically have longer terms, like 10 to 15 years. So while the interest rate may be lower than the credit card rate, the term is going to be much longer. So in the long run, you may end up paying more in interest than you would just aggressively paying down the credit cards,” Seh explained.
Aside from HELOCs, debt consolidation loans can sometimes be helpful. However, as Seh noted, “you want to be careful of fees and higher interest rates.”
You also want to be careful of taking out loans or withdrawing from a retirement account to pay off debt. If you can’t pay back the retirement fund loan, that becomes a taxable event, Seh said. “Also, you are depleting your retirement account, which negatively impacts the power of compounding interest,” she explained.
So before rushing into these options, consider all the pros and cons.
Make a Plan You Can Stick To
Lastly, Seh emphasized the power of coming up with an overall debt plan that you can adhere to for the long run rather than looking for instant results.
“You need to create a plan and stick with it,” Seh said. “You have to be disciplined when it comes to paying down the debt. You have to be patient. It’s not a fix that’s going to happen overnight.”
More From GOBankingRates
This article originally appeared on GOBankingRates.com: I’m a Financial Advisor: 7 Pieces of Advice I Give My Clients With Debt
