The Importance of Debt Management

debt management

Even a little debt can snowball. Interest rates can mean that even regular repayments are only just enough to keep you afloat, and poor debt management can quickly see things get out of control.

No matter how much you owe, debt management is crucial to avoid small amounts of money owed turning into ever-increasing money problems. When it comes to understanding your debt, financial literacy is paramount, and misplaced confidence in their debt juggling skills can often lead spenders into greater financial difficulty. 

The post in the link above does a great job of explaining the four pillars of financial literacy – debt, saving, budgeting and investing – and how best to manage your money so you can see the big picture.

It’s a good idea to make a list of your debts, your monthly payments and your due date so you can refer to this list as you pay your bills. Your credit report can help you confirm the debts you have to pay, and make sure you update your list periodically as the amount you owe changes.

Paying your bills on time is an important part of debt management to avoid even more debt piling on due to late payment fees. A calendar reminder can help you stay on top of what payments are due so you never miss one – otherwise you could see your interest rates increase.

Decide what debts to focus on

It’s a good idea to pay your credit card debts first, as credit cards often have the highest rate of interest when it comes to debt. If you have more than one credit card to pay, choose to pay the one with the highest interest rate first, as this is the one that will cost you the most money.

Even if you can’t afford to pay off much of your debt, you should always make the minimum payment. Even though it won’t make a big difference due to interest rates, it will keep your debt from growing and ensure that your credit rating remains intact. Missing the minimum payment can make it very hard to catch up.

Once your biggest payment has been prioritised, go through your debt list and decide in which order they ought to be paid. If you have enough money, you could choose to pay off the debt with the lowest balance first, simply to get it out of the way and cross it off your list. 

Managing debt with limited funds

Don’t pay more than you can afford – or debt begets debt. If you find yourself with inadequate funds for repaying debt, focus on keeping your other accounts in the black. It’s a bad idea to sacrifice positive accounts to pay off those that have already hurt your credit, or you will just end up with more negative accounts to deal with. Just pay your outstanding accounts as soon as you can afford to do so.

When you can, you should work towards creating a backup fund to fall back on in times such as these, so you can avoid getting into deeper debt. Even if you don’t have much to spare each month, saving a little here and there adds up, and can really get you out of a bind when you need it. Even a small emergency fund will cover a few crucial expenses, and you’ll be glad to have it.

Use a monthly budget for debt and expenses

It’s important to create a monthly budget plan so you can ensure that you have enough money to cover your monthly expenses so that your debt does not grow.

Instead of budgeting from month to month, plan far in advance so you can see potential problems coming before they hit. If it looks like you won’t have enough money for your bills in the coming months, you can take action now to prevent issues arising later. A budget like this can also help you see where you can put away any extra money into your emergency funds, or use it to pay debt off a little faster.

Get help to manage your debt

You don’t have to suffer with your debt alone. If you are finding it too difficult to pay your debt and other bills every month, a debt relief agency can help you sort through your options. Debt consolidation and bankruptcy are also options to help you manage debt, although each one has pros and cons that can affect your financial future, so it is vital to be well-informed of the consequences before making a decision.

If you are worried about falling back into bad spending habits and accumulating more debt, or if you feel you have a spending problem that is preventing you from managing your debt, there are groups such as Debtors Anonymous that can really help you figure out the root of your problem, helping you to get back on track.

How is Your Credit Score Calculated?

Quick, what’s your credit score? If you’re like most people, you’ve checked your credit at least once in the past 12 months. You probably know this number off the top of your head.

But what about how your score gets calculated? Now that’s a tougher question — and one that four out of 10 Americans don’t know the answer to.

If you don’t either, keep scrolling to find out how FICO generates your score — and how you can use this information to start building credit. 

score calculation

1. Payment History

Accounting for 35 percent of your credit, your payment history is the most important factor affecting your score.

This section of your credit report shows how you pay your debts, including mortgages, student loans, and credit cards.

Even an online personal line of credit may count towards your payment history. To understand how a personal line of credit works towards your score, read more about how some lenders report to the major credit bureaus.

FICO rewards people who pay bills on time, so one of the best ways to maintain or build a good score is by paying off debts by their due date.  

2. Amounts Owed

The next largest component of your score is amounts owed. This section reveals how much available credit you’re using, and it’s worth 35 percent of your score.

FICO may dock points if you consistently carry a large amount of debt, but it isn’t always a given. FICO compares amounts owed against your payment history to get a better understanding of your finances.

A large balance on your online personal line of credit may not lower your score if you manage to keep the account in good standing. However, it could do harm to your score if you end up missing payments.

3. Length of Credit History

This category, worth 15 percent, reveals how long you’ve held each account under your name. Generally, FICO favors older accounts over newer ones.

Why? Well, let’s compare a personal line of credit that you’ve had for 5 years with one you just opened last week.

The new line of credit may not have anything to show. But the older line has five years’ worth of payment history and amounts owed attached to it. There’s simply more data here for FICO to crunch.

If you only have new accounts, you may end up with a low score because FICO simply can’t determine anything about your payment habits.

4. Credit Mix

As with credit age, credit mix is part of FICO’s desire to collect as much data on your credit behavior as possible. Preferably, FICO wants to see you balance a wide variety of accounts under different conditions.

If you manage to keep a mortgage, installment loan, auto loan, and personal line of credit in good standing, this may help build credit.

But don’t get a personal line of credit and installment loan just to diversify your profile. Even the best personal line of credit and online loan may tank your score if you take on debt you can’t afford.

5. New Credit

It’s alright if you apply for personal line of credit loans and credit cards every once in a while. But opening several new accounts in a short period of time may flag you as a credit risk.

Many traditional lenders use a hard credit check when reviewing your application, which shows on your report. If you have several hard inquiries performed in a short amount of time, these hard checks may lower your score — especially if you don’t have older accounts to balance them out.

Knowing how a lender assesses your credit before extending a loan or line of credit can help you avoid hard credit checks. Some lenders use soft inquiries, which don’t show on your credit reports.

Bottom Line

Your credit may seem like it’s a mystery at first. But there’s actually a simple explanation behind your three-digit score. It all depends on how well you handle paying bills and managing debt.

If you plan on building credit, start by focusing on making timely payments to lower how much you owe. Everything else will eventually fall into place when you focus on these main components of your score.