Debt Management 101
DEBT, meaning “a sum of money that is owed or due,” tends to have a negative connotation, leaving us slightly embarrassed when we speak of our own personal finances. But guess what? Debt accumulation can actually be a good thing when it comes to making major life decisions, as long as the debt is managed effectively. Beware, however, the reverse is also true - the accumulation of debt along with poor management skills can spark a damaging cycle, resulting in eventual default. Fortunately, we are here to help you Get Money Smart Bahamas, as you work your way through Debt Management 101:
GOOD DEBT VS. BAD DEBT
The first thing you need to know when it comes to debt management is that there is both good debt and bad debt. Let us look at some examples of both:
While it is possible to live your entire life free of debt, this is not feasible for many, due to income limitations. Good debt entails borrowing funds to generate long-term income, increase your net worth, and assist with goals that will enhance your financial stability and quality of life. There are two main categories of good debt:
Loans that advance your ability to purchase long-term assets, for example: homes, business vehicles, and investments.
Loans that can assist with increasing your income flow, for example: business ownership, income generating property, and education loans.
Bad debt entails borrowing funds to purchase items that quickly lose value and do not generate long-term income. It usually involves taking on borrowed money simply to enhance a standard of living that you cannot afford with your income alone. A few examples of bad debt include:
High amounts of unsecured debt accumulated due to frivolous spending, i.e. credit cards with high unpaid balances or other lines of credit.
Loans for lifetime events such as weddings, vacations, baby showers, and other celebrations.
Loans for purchasing assets that do not assist with wealth accumulation, for example: furniture or electronic gadgets.
SIX DEBT MANAGEMENT TIPS
“Oh no! I have already accumulated a high amount of debt. Am I financially doomed?”
Do not fret if the above statement is on your mind. All types of debt require a debt management strategy and the tips below are geared to assist all persons looking to better their financial position.
1. Assess your financial health!
Understanding where you are financially is the first step in your debt management process. It helps to write out a list of:
Your monthly income, inclusive of:
Investment income, etc.
Your monthly expenses and commitments, inclusive of:
Tithes and offerings,
Insurance premiums, and
Grocery shopping, etc.
Your monthly bill payments, inclusive of:
Electricity bill, and
Your current savings, inclusive of:
Credit union savings,
Bank savings amounts,
Christmas savings, etc.
Your current investments, inclusive of:
Money generated from income generating property (e.g. apartment rentals and commercial property), and
Money in investment accounts (e.g. mutual funds and pension accounts), etc.
Your total debt amount, inclusive of:
Credit card balances,
Furniture loans amounts, and
Personal loan amounts, etc.
2. Be realistic with how much debt you can take on!
The credit bureau is not in place yet; however, you can assess how much you can afford based on something called a debt-service ratio (DSR). Your DSR is the portion of your income that goes towards servicing your debts. Lenders usually use this ratio when someone applies for a mortgage to determine if the borrower can manage the monthly payments. To calculate your DSR, add all of your monthly debt payments and divide them by your monthly gross income. This number should ideally be no more than 40%. If your number is higher than this, there may be cause for concern. Do not panic though – it’s time to make a plan to reduce your debt-service ratio so that you can move towards greater financial freedom.
3. Create a budget and stick to it!
This particular step takes discipline, and it is a skill that can be learned over time. A budget is an estimation of your income and expenditures during a specific time in the future. As you create your monthly budget, it is important to track what you actually spend and what you actually save. This allows you to better understand your money habits and take control of your finances. Remember, the key to proper budgeting and saving is to only spend what you can afford. A few things to take into consideration when budgeting are:
Set emergency savings aside (leave room for the UNEXPECTED);
Pay expenses before spending; and
Set aside money in advance for items you need to purchase in the near future, e.g. a new television.
4. Watch your credit card balance!
If you have a credit card, these tips can help you manage the debt you accumulate:
Do not use credit cards to purchase items you cannot afford or to pay other bills.
You should pay your monthly payment in full and on time to avoid extra charges, late payment fees, and over limit fees.
If you can, you should pay more than the monthly payment. This will help to reduce your balance quickly.
Try to keep your balances low. The interest rate on most credit cards is roughly 18%, which is high. To avoid high interest amounts, keep your balances low and make your payments on time.
Extra Tip: Credit cards should not be used to purchase items just to keep up with the Johnsons, or whomever else you want to impress! Where possible, use cash or debit cards for purchases rather than credit cards.
5. Find ways to lower your debt quickly!
If you find that you are swamped with debt, there are ways to get it under control, for example:
Make an effort to pay off your high interest rate loans first.
Consider consolidating your debt. Debt consolidation is essentially taking out a new loan to repay a number of debts. This allows you to have a single loan, normally with more favourable terms (i.e. one lower monthly payment, lower interest rate, less fees, etc.).
Make extra principal payments when you can. This will help you to pay your loans faster while saving you lots of money in interest. A good strategy is to put a portion of your bonus or a portion of a salary increase towards principal repayments.
6. SEEK HELP!
This cannot be stressed enough. If you find that the above tips are too much to handle on your own, seek help from a local financial institution or a certified financial planner. Some financial institutions offer financial advisory services that can help you make a suitable plan to reduce your debt. Your loan officer may be able to assist with debt consolidations and other ways to help you become debt free.
GET MONEY SMART BAHAMAS
Managing and lowering your debt always creates a great feeling and provides peace of mind. Imagine all the things you could be doing with the money used to pay your current debts. GET MONEY SMART, put these tips to good use and begin your journey to financial freedom today.
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