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How to manage debt: The full breakdown

At a glance:

If you find that there is still a week or two until your next paycheck and you're already broke, you may be suffering from too much debt. It's easy to fall into this trap. But there is hope.

The way out of debt is lighted by a clear understanding of the reasons people fall into the trap. You need to know how much debt you can handle and the difference between manageable and unmanageable debt.

Sometimes it is not possible to handle this alone. In that case you need to know who you can turn to for help in getting out of debt.

Once you have gotten your debt under control, the next step is getting your credit rating back on track. If you know the right people to contact and what to say, you can do this on your own. The more you know about debt, credit, and how to manage it, the better off you'll be financially.

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How to figure out how much debt you can handle

If you feel that you have too much debt, you are not alone.

Debt is very common

Most people have substantial debt; many have more than they can handle. However, debt is not all bad. Sometimes it makes sense to use borrowed money for investments. However, most folks are not using debt in that way; they are using it to make ordinary purchases of things they would probably be better off without, anyway. Sometimes in our competitive society, spending has become a status symbol. This can encourage people to spend more than they should – more than they have. Consequently, they run up tremendous debt.

While some debt is okay, too much debt is not. So, how do you know whether you have too much debt or not? First, let's look at the different kinds of debt we might incur.

Two kinds of debt

First, there is investment debt, such as the debt incurred to buy a home (mortgage) or to start a business. Generally this kind of debt is used to purchase assets that, when liquidated, will provide cash to repay the debt, or will provide income or have use value over the life of the loan that offsets the debt repayments. For example, if you borrow money to buy a house, you will have the use of the house that offsets any rent payments you might have had to pay for other shelter.

Consumer debt is the borrowing of money to buy things that decrease in value with use or over time. If you borrow money to buy a car, clothing, holiday gifts, etc., you are using consumer debt. Consumer goods generally become worth less over time or with use. They are consumed. But the debt remains.

Understanding minimum monthly payments

The monthly payments hurt the most

Interestingly enough, it is not the amount of debt that is a problem for most folks. It’s the monthly payments. There are three factors that determine how much each monthly payment will be.

First, there is the amount of principal to be repaid. Second, there is the rate of interest on the unpaid principal – the annual percentage rate (APR). Finally, there is the number of monthly payments.

Obviously, the more you borrow, the larger your monthly payment will be over a fixed number of months at a fixed rate. If the number of months is increased, the monthly payments will be reduced. Likewise, a lower rate will lower the monthly payments for the same amount of debt as long as the number of months remains the same.

Southern states have more credit card debt. (David Foster/Cashay)
Southern states have more credit card debt. (David Foster/Cashay)

Understanding the minimum monthly payment

Some debts obscure the number of payments due, as well as the interest rate. Consumer revolving credit, like credit card debt, is an example. Sure, you know how much you borrowed when you made the credit card purchase, but you may not have been cognizant of the actual interest rate or the number of monthly payments. This works in the lender's favor and against you.

When a lender tells you what your minimum monthly payment is, you may be unaware that it barely pays the monthly interest and allocates only a small amount against principal. Revolving credit rates may vary, so it is that much harder to track your loan. Using the lender's minimum monthly payment could result in taking years to repay even a small debt. The result is that you pay much more for the loan than if you took a conventional loan with a fixed rate and fixed number of payments.

How to tell if you have too much debt

In order to determine whether you have too much debt, you need to calculate what percentage of your monthly take-home pay goes toward paying consumer debt. Add up all of your monthly debt payments excluding your mortgage and divide that by the amount of your take-home pay. While there is no "magic" number, if you are uncomfortable with the percentage of your pay that is going toward debt, you may have too much debt and need to take measures to reduce your monthly debt payments.

How to create a spending plan and stick to it

If you really want to reduce your debt, the first thing you will need to do is create a spending plan, then stick to it. Your spending plan, or budget, needs to focus on paying down your debt and not adding to it. This may mean cutting up the credit cards and avoiding sales and bargains that are too good to be true. Set your primary financial goal to be out of debt in six months, a year, two, or whatever it takes. Write it down. You need to stick to this plan until you have achieved your goal.

Here's how to start

Identify and prioritize essential expenses. Limit your spending to the bare essentials: food, shelter, utilities, etc. It may be difficult to define what is essential and what is "luxury," but if you are to get out of debt, you must be tough. Make a list of essential expenses and how much they cost on average each month. Do not forget those expenses you pay only once or twice a year, such as insurance premiums or property taxes. If you can economize and reduce some monthly expenses, do that.

Some specific ideas

You may reduce utility bills by carefully adjusting the temperature in your home by raising the thermostat in summer and lowering it in winter. Turn lights off in rooms when no one is in them. Spend less time on the telephone. Avoid expensive convenience foods and buy raw ingredients to prepare less expensive, more nutritious meals. Make gifts instead of buying expensive items to give away during holidays and for special occasions. If you set your mind to it, you can come up with many ideas that may save you pennies a day, which add up to dollars you can use to reduce your debt.

Write your expenses down. Write down how much they cost each month. Once you make your list, do not buy anything that is not on it until you reduce your minimum debt payments to below 15% of take-home pay.

Something to note about your monthly debt expenses

By the way, your monthly debt payments are not expenses. Except for your mortgage payment, which is like rent, debt payments are the ghosts of prior months' expenses you incurred when you did not have enough cash to pay for them. Furthermore, they are causing you to pay more and more for those prior expenses because they have hidden expenses – interest and finance charges.

Now take note of your income

Make a list of all your take-home income. This is what you have available to pay your debts and essential expenses. Do you usually get a large income tax refund each year? If so, adjust your withholding at work so you get the money each month when you need it.

Now deduct your monthly debt payments (except your mortgage) from your income. This is what you have left to pay essential expenses. Here is where many get into trouble. If you find that you do not have enough to pay debts and expenses, you will need to take additional action. Some people simply start juggling debt payments by making minimum credit card payments or paying one bill this month and another the next. This is a bad move.

Learn to economize

Revisit economizing. Look at those expenses again. Economize where you can. When you get to the point where you simply cannot cut expenses any further, you have one of two choices: earn more income or lower your monthly debt payments. It might be necessary to take another job, or have a non-working spouse take a job to bring in additional household income. Lottery tickets and casinos won't do it—do not waste money. Reducing your monthly debt payments is a little trickier. Avoid the temptation to juggle payments – that only costs more in the long run, and it may damage your credit rating.

How to pay off debt

Figuring how much to pay toward your debt each month

If you set a priority of being out of debt by a certain date, you will need to determine how much you must pay each month until that date to reduce your debt payments to a manageable percentage of your take-home pay. This is particularly important if you have a lot of installment credit or credit card debt. To calculate this amount, you will need a financial calculator. In the following paragraphs are the basics to determine how much you should be paying each month to eliminate your debt by your target date:

Determine the amount of debt and the interest rate to use

Determine how much debt you want to eliminate by the target date – this is the principal (P). For example, suppose you have several credit cards totaling $10,000 and a student loan balance of $10,000. If you only want to pay off all the credit cards and half the student loan in three years (you feel you can manage the rest of the student loan later), your principal will be $15,000.

Determine an interest rate to use. The highest rate from all your loans might be the best one to use, as it will help you calculate your way out of debt faster. Let's say that you have one credit card balance with $7,000 at 15%, another with $3,000 at 7%, and the student loan ($10,000) at 3%. Choosing 15% as the rate (R) will help you calculate payments to most quickly reduce your debt. Of course, you could use a weighted average, but we will leave that for a mathematics textbook to explain.

Set the term (N) as the number of months or years to achieve your goal. In our example, we are using three years or 36 months.

The result

When you plug these numbers into a financial calculator, you will come up with a monthly payment (PMT) equal to approximately $520. This is the number you should use to get out of debt in the time you set as a goal. All you need to do now is to allocate how much of the payment should go toward each of the loans you are paying off. The best way to allocate the payment is to pay off the highest-interest-rate loans faster than the lower-rate loans. In our example, we might allocate the largest amount to the 15% credit card, with lower amounts to the others.

If your calculated payment is still more than you can afford, you will need to consider refinancing methods. However, if this works for you, why not continue to make those larger monthly payments to your savings and investment plans after your debt is gone? This will help you stay out of debt.

Trading unmanageable debt for manageable debt

If you are like many people who find themselves with too much debt, you may need to consider refinancing or consolidating your loans. You might find yourself in a predicament where no matter how hard you try, you just cannot cut expenses any further or earn more income. The only solution is to lower your monthly debt payments.

There are only three ways to lower monthly debt payments: reduce the principal amount, get a lower interest rate, and extend the payments over a longer term. These three principles are used in refinancing and debt consolidation. Let's see how these work and then look at the advantages and disadvantages.

Refinancing: changing the principal, interest, and payback period

Refinancing debt means simply changing the terms of the debt agreement.

This means that an old debt is replaced with a new debt, usually for the same amount, but with different repayment terms such as a new interest rate and repayment period. Refinancing can help those who find themselves with excessive debt because it allows a loan to be repaid with lower monthly payments.

Monthly loan payments can be reduced if a loan is refinanced with either a lower interest rate or longer payment period, or both. This is clearly an advantage to those with a cash flow problem. An advantage to a lower interest rate is that the cost of borrowing is lowered as well.

A longer payment period generally costs more for the borrower, since the interest payments stretch over a longer term hence a more costly loan. Refinancing may involve costs that need to be considered as you determine whether refinancing is the right choice for you.

Advantage of secured long-term debt

There are many reasons why some loans have lower interest rates than others. Long-term loans generally have higher rates than short-term loans. Secured loans also have lower interest rates than loans for which there is no collateral. A mortgage, for example, is a long-term, secured loan. If you follow mortgage rates, then you know that they are lower than the rate for an unsecured personal loan from your local bank or finance company.

The problem with unsecured short-term debt

Many persons with excessive debt usually have many short-term unsecured loans or credit card debts with high interest rates. This puts a burden on the family finances because there are too many monthly payments, leaving little left to pay for ordinary family expenditures. If these people refinanced their loans, they might be able to reduce their monthly payments so they could better manage their finances.

One must be careful, however, to avoid stretching payments so long that doing so increases the cost of goods too much. For example, if you bought a TV for $1,000 with a revolving line of credit at 12% and paid it off in 12 months at $89 per month, the net cost would be $1,066. That might be reasonable, especially if you got a good deal on the price to start. However, if that loan was refinanced to 60 months at $22 per month, the cost would go up to $1,335 – not such a bargain.

How to refinance and consolidate debt

Using home equity to reduce your payments

Some folks with high consumer debt – loans for things like cars, clothes, vacations, etc. – may also have equity in their homes. It might make sense for such persons to use the equity in their homes to consolidate their high-interest, unsecured consumer loans for low-interest, secured home equity loans. The result could be lower monthly payments. Interest on consumer loans is not deductible from income for federal income tax purposes. So consolidating your consumer loans by refinancing your home, or taking a home equity loan, could save you money and improve your cash flow.

It's better to refinance in the western half of the U.S. (Graphic: David Foster/Cashay)
It's better to refinance in the western half of the U.S. (Graphic: David Foster/Cashay)

Refinancing/consolidating tips

When refinancing or consolidating (combining) loans, consider the following:

  • Do not combine lower-interest-rate loans into a higher-interest-rate consolidation loan.

  • Be careful about consolidating short-term loans into longer-term loans, because this increases the costs in the long term. If you are consolidating short-term loans into a longer-term loan to improve current cash flow, accelerate payments as soon as you can on the longer loan to mitigate the additional cost.

  • Consolidating loans often trades unsecured loans for secured loans, which can put the collateral (your home?) at risk.

  • Refinancing and consolidating loans usually have additional costs, which may not make them worth the costs. Buyer beware.

  • Refinancing and loan consolidation may be ways to reduce your monthly debt payments, leaving you adequate cash flow to meet your necessary expenses. They may also provide you enough slack to resume savings.

Another approach

There are those who take a different approach to their debts. Instead of consolidating them, they pay off certain ones first, and then apply the payments that would have gone to those debts to the other ones. This can provide a feeling of accomplishment that motivates them to continue paying down debts.

When to find help in managing debt

There are many reasons why people find themselves in financial difficulty. The key to resolving financial woes is understanding why the problems arose, making a plan to resolve the problems, and taking action to get back on track.

Deal with the causes of your debt

In the past, you may have managed your debt well – until you lost your job or had a financial setback due to large medical or legal expenses, or investment losses. You may have incurred large debt due to poor spending habits, overuse of credit cards, poor budgeting, or even gambling. Before you can resolve your debt issues, you need to deal with their causes or the problems will likely recur. Some of these issues you can resolve on your own, while others will require professional help.

Time to get help?

If you have done all you could to reduce spending, made a budget, and consolidated your loans, it may be time to get help. If you still cannot make minimum payments on your loans, try speaking to your creditors. Explain your situation and how you intend to rectify it. Creditors may revise your loan terms or even suspend interest temporarily in order to give you time to repay your loan. Creditors would rather receive some payment than risk not getting any payments should you resort to bankruptcy.

Debt counseling and bankruptcy

Counseling agencies

Creditors are leery of "deadbeat" debtors, so you may not be able to convince them of your sincerity. You may need to consult with the consumer credit counseling agency in your community. Often, creditors will work with a consumer credit counseling service to renegotiate and consolidate your debt so you can make manageable payments. However, your credit rating may be damaged if your debt is not paid in full, because creditors will report charge-offs and slow payments to the credit bureaus that track consumer credit information.

You also need to be careful about selecting a credit counseling or debt consolidation service, as there are many questionable firms entering the market. For a list of reputable services, contact the National Foundation for Credit Counseling (, the Financial Counseling Association of America (, or the Better Business Bureau ( It is a good idea to check a couple of these organizations to see what services they will provide and how much their fees are. Reputable firms charge customers low fees—creditors pay fees to credit counseling services, which saves you money.

Bankruptcy as a last resort

If you cannot get relief from your creditors or consumer credit counseling services, you may need to file for personal bankruptcy. This should be your last resort. If you file for protection under the U.S. bankruptcy laws, your credit record will report your action for 10 years, which may adversely affect your ability to borrow money.

Individuals filing for bankruptcy usually apply under one of two sections of the U.S. bankruptcy code: Chapter 7 or Chapter 13. Bankruptcy generally protects persons from their creditors, but how it does this is different according to the section under which one applies. Chapter 7 is generally referred to as the liquidation bankruptcy, while Chapter 13 is based upon the restructuring of debt.

Getting professional help with bankruptcy

Should you decide to consider bankruptcy, consult with a bankruptcy attorney in your community. You can file for bankruptcy on your own; however, you will probably fare better with professional help. Check your local telephone directory or the Better Business Bureau ( for bankruptcy attorneys in your area.

Why your credit rating is important

Even if you have not fallen on hard times, you need to know about your credit rating and how to make sure it accurately reflects your credit history.

The credit bureaus and your rating

Negative information in your credit report can adversely affect your ability to get credit or get the best loan interest rates. Information about your credit history is collected by credit bureaus, who then sell this information to lenders and others who need it in connection with loans, getting a job, or other financial applications you may make. You must authorize the credit bureaus to give out this information by signing a waiver on an application you make.

There are three primary credit bureaus in the United States who collect and disseminate this information: Equifax, Experian, and TransUnion. You should obtain a copy of your credit report from each of these bureaus at least once a year to verify that the information they have is correct.

Why your credit rating is important

You build your credit report every time you apply for and use credit. Creditors send information about your credit history with them to one or more of the credit bureaus. Most of the information is accurate and timely, but sometimes it is not.

When you miss loan payments, pay late, default on a loan, or have a debt dropped (called a charge-off), that information goes on your credit report. Even legal information, if you have lawsuits or judgments against you, may find its way on to your credit report. When you authorize a potential employer, creditor, or other person to get this information, they will make a judgment about you and your creditworthiness (trustworthiness).

So, it is important that the information in your report at least be accurate and, better yet, positive information. Generally, information remains on your credit report for seven years. If you file for bankruptcy, that information may remain on your report for up to 10 years.

Credit score report with keyboard
Generally, information remains on your credit report for seven years. If you file for bankruptcy, that information may remain on your report for up to 10 years. (Photo: Getty Creative)

Dispute any false information

While no one can legally remove accurate and timely negative information from your credit report, you do have the right to request a re-investigation of the facts and to dispute inaccurate information. So, if you find that you have questionable information on your credit report, you should contact the reporting agency for a dispute form, or send your own letter with a copy of your report clearly showing which items you are disputing and why you dispute them.

The credit bureau is required to investigate and send you their findings along with a corrected credit report if changes are made. If your dispute is not resolved, then you have a right to have the credit bureau send a copy of your side of the issue along with their credit report to those requesting your report.

A good credit report comes from a good credit history.

The best way to improve your credit report is to have a good credit history. If you are just starting out or if you need to do "credit repair," obtain and use a secured credit card, being sure to pay the full balance each month – you do not need the extra finance charges.

Secured credit cards are issued by some banks, credit unions, and credit card companies that require you keep a minimum balance in a savings account to secure the card. For example, if you keep $500 on deposit, you can get a credit card with a $500 credit limit. Be sure to pay all your bills on time – make and stick to a budget.

How to contact the credit bureaus

You can get a copy of your credit report from each of the three credit bureaus by contacting them at:

The law now allows consumers to get a free credit report once every twelve months from each of the three national consumer credit reporting companies (Experian, Equifax, and TransUnion). These three major credit reporting agencies have set up a Website – – to provide free access to annual credit reports.

If you've been denied credit

You may be entitled to a free credit report if you have been denied credit because of a credit report, within 60 days of denial. Otherwise, the credit bureaus may charge you a small fee for a copy of your report. You should get a copy of all three reports, as they may contain different information from different creditors.

Dispute any and all inaccuracies. You do not need to hire a credit repair agency. Such companies cannot do for a fee anything you cannot do on your own for free. No one can legally make your credit history go away or give you a "new credit identity." Checking your credit report regularly is especially wise, considering all the incidences of identity theft in this day and age.

For more information on credit from the Federal Trade Commission, visit its website.

Summary of debt management

Debt is not a bad thing; too much debt is. The bad thing about debt is not the amount you have, but the fact that you may not be able to handle your monthly payments and provide for your and your family's financial needs. There are many reasons for falling into too much debt. Regardless of the reason, the way out requires behavior modification – doing things differently.

If your minimum monthly payments toward your debt, exclusive of your home mortgage, exceed 15% of your monthly take-home pay, then you may have too much debt and need to do something about it. You need to have a strict spending plan to provide additional cash to repay your debt and curb you from falling deeper into debt.

You might be able to combine your debts by refinancing some higher-interest rate loans for lower-rate ones, or by extending payments over a longer term (but this costs more in the long run). You may need to speak with your creditors about modifying your debt arrangement so you can lower your monthly payments to a level you can afford.

You may need professional help in getting out of debt. Consumer credit and debt consolidation services may be able to help you. If they cannot, then you might need to seek protection from your creditors using the federal bankruptcy laws – but this should be your last resource.

Once you have the discipline to economize and get out of debt, use that discipline to start saving extra money each month to build an emergency fund and to save for future needs and avoid future debt problems.

Practical ideas you can start with today

  • Determine what percentage of your take-home pay goes toward paying off debt.

  • Create a budget that allocates as much as possible toward debt reduction.

  • Obtain your credit report from all three credit bureaus once per year.

  • Contact a consumer credit counseling agency.

  • Consider bankruptcy as a last resort.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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