How Managing Debt Makes You Financially Literate

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Contributor, Benzinga
October 26, 2023

When it comes to investing, time is always of the essence. The sooner you can start investing, the better you’ll be long-term. Even the best stock picker would be hard-pressed to match an investor's returns with a 10-year headstart. There are a few scenarios where an early investment plan isn’t the best long-term strategy. For example, if you need money for an upcoming expense like a wedding, that cash is better off in a Federal Deposit Insurance Corp. (FDIC)-insured vehicle.

Another reason to wait to invest right away is debt. Not all debt is bad — if you have a mortgage, you don’t need to worry about paying it off before putting money into stocks. But if you have high-interest debt like credit cards or student loans, dealing with them first is probably a good idea. Not only will you improve your long-term results, but you’ll learn how to manage money responsibly through financial literacy.

Managing Debt and Financial Literacy

Like learning to read, financial literacy requires knowledge of several different but interlinked concepts. To successfully manage your debt and begin saving or investing, you must understand how compound interest works and what tools are available to reduce your burden. 

For example, can you get a better personal loan rate than a credit card? Can investment returns outpace the accumulation of high-interest debt? Being in debt can sometimes force a borrower’s hand into financial literacy because knowledge of money and markets is the primary weapon for defeating a seemingly insurmountable debt load.

6 for Steps Managing Debt

The first step is always the toughest when managing debt, but the sooner you take action, the quicker you’ll dig yourself out of the hole. Here’s a comprehensive six-step process to get you started on your journey:

1. Understand Your Debt Situation

The first step in any debt-management plan is figuring out exactly how much you need to pay off. If you aren’t sure what your total is, don’t be alarmed — people with heavy debt often don’t know how deep in the hole they are. You can ignore reasonable debt like a mortgage or low-interest car loan and focus on high-interest items like credit cards, student loans or personal loans. How much do you owe and at what interest rate? Write it all down (or use a debt-tracking app) so you can consult it later.

2. Check Your Credit Report 

Next, get a copy of your credit report from one of the three reporting bureaus (Equifax, TransUnion, Experian). You’re allowed one free copy per year from each bureau, meaning you can get a full credit rundown three times annually. Your credit history is more than just a FICO score; you’ll see which items most negatively affect your credit and can plan to resolve those first.

3. Make a Plan for Paying Off Debt

Once you understand your debt load and credit situation, it’s time to implement a plan.  Debt management plans won’t be identical from person to person, but the main facets will be similar.

  • Decide how much you need to pay. Paying more than the minimum is the key to escaping a never-ending debt spiral.
  • Figure out how much money you allot for payment. What percentage of your monthly income can be devoted to debt payments? Can you reduce costs elsewhere in your budget, or do you need to increase your income?
  • Determine your debt-reduction strategy. There are two schools of thought: the snowball method and the avalanche method. The snowball method attacks the smallest debts first, while the avalanche method puts the most significant obligations in the crosshairs. Always consider interest rates on your debts when choosing a strategy.

4. Track Your Progress and Refine Your Plan

Once your plan is in place, you’ll need to track it.  Debt-management plans shouldn’t be static. For example, suppose you receive a windfall like an unexpected work bonus. You can use this windfall on the principal of your highest-rate loan or credit card, which can shorten the time required to fulfill your obligations.

5. Use Financial Tools

If you have a smartphone, you have access to financial tools that can make your life easier. A budgeting app is an excellent place to start. How much income do you take home monthly? What goes toward nonnegotiable monthly costs like rent or mortgage, insurance and utilities? A tracking app lets you stay on top of your finances by clearly showing your assets, obligations and cash flow.

6. Consider Debt Consolidation

Adding more debt to reduce current debt may sound counterproductive, but lowering your interest rate could be even more beneficial than increasing monthly payments. For example, if you have credit card debt with a rate of 20%, you might consolidate that obligation into a personal loan with a much lower rate.

You might try a platform like Accredited Debt Relief, which doesn’t require a loan. You set up a savings account, pay into that account and the platform negotiates your balances on your behalf. Plus, it helps educate you so you can stay out of debt in the future.

5 Tips for Managing Debt

Here are a few tried-and-true debt management tips. If you can apply these early, you’ll find the path out of debt much easier to navigate.

  • Pay debt promptly: Time is always crucial in financial matters. The sooner you can pay off your debt, the less interest you’ll pay over time.
  • Pay more than the minimum: Only paying the minimum can keep you in debt for years — even decades — if you have high-interest credit card debt. By paying more than the minimum, more of your payment will go toward the principal, not interest.
  • Monitor your credit regularly: You can get three copies of your credit report annually, so use them. Nothing can sink a debt-management plan faster than unauthorized activity or identity theft. Plus, you have periodic updates on which areas of your credit need the most attention.
  • Determine your debt-to-income (DTI) ratio: DTI is one of the biggest factors lenders look at when determining borrowing rates. Keeping your DTI at a moderate level will open access to friendlier and more affordable options.
  • Apply for lower rates: High-interest credit card debt is the biggest scourge in finance. Always ask your card provider for a lower rate if you have a history of on-time payments. Consider a lower-rate personal loan or a balance transfer card if your request is denied.

What’s Next Once You Pay Your Debt?

Once you’ve paid off your debts, you can start worrying more about your future goals. One of the first things you should do is build an emergency fund in a savings account. Having emergency savings can prevent debt from rearing its head down the road. Next, create monthly goals for savings and investment just like you did when managing debt.

Service High-Interest Debt Before Investing

No one wants to suffer under a mountain of debt, but a high debt load can be a springboard into financial literacy. You’ll need to learn certain money concepts like compound interest, amortization and budgeting to get out of the spiral. It’s often said that necessity is the mother of invention, meaning that strong actions come from strong needs. So, to escape a debt spiral, you must develop financial literacy skills.

Frequently Asked Questions

Q

What is the importance of managing debt?

A

Mismanaging debt can negatively affect your credit report, making it harder to get a loan, mortgage or apply for an apartment.

Q

What is the best way to manage debt?

A

Manage your debt by keeping a budget or spending within your means. Avoid credit cards if you struggle to pay your bills on time.

Q

How to avoid debt?

A

Prospective investors shouldn’t avoid all debt — it would be impossible for most people to buy a house without some type of loan. But avoid high-interest debt because it can hinder credit scores and siphon off money that should be ticketed for savings or investments.

About Dan Schmidt

Dan Schmidt is a finance writer passionate about helping readers understand how assets and markets work. He has over six years of writing experience, focused on stocks. His work has been published by Vanguard, Capital One, PenFed Credit Union, MarketBeat, and Fora Financial. Dan lives in Bucks County, PA with his wife and enjoys summers at Citizens Bank Park cheering on the Phillies.