Managing Your Family Debt: 5 Key Principles

It seems that most debt advice is tailored for people who are already in over their heads. But wouldn’t it be better if you mastered your finances before your debt spiraled out of control? Managing your family’s debt can be challenging; the following guidelines can help.

Communicate

If you and your partner are money opposites, it can be tempting to avoid conversations about money. At best, they can bring up feelings of anxiety and guilt. At worst, they can become fights. However, you must learn to talk constructively about money, for the health of your relationship and your finances. Subtract the emotion and judgment, then add a willingness to compromise. That is the formula for real progress.

If you have children, get them involved as well. Explain loans, payments and interest to grade-school kids with play money. For older kids, use an online calculator to show the difference between a big-ticket item’s stated purchase price and the actual price after financing. Include children in discussions about financial goals and household expenses.

Know Your Net Worth

You should always know where you stand financially. Create a net worth statement and update it twice a year. Software and apps can simplify the process. Check your credit report at least once a year, to help with your net worth statement and guard against identity theft. Examine monthly spending as well. For the most accurate figures, use a smartphone app to track all expenditures for at least three months.

Plan Ahead

Now that you know where you are, figure out where you want to go. You have completed your descriptive budget, which shows you where your money is going now. At this point, set some financial goals. Limit yourself to just three, such as paying off current credit card balances, taking a summer vacation and completing one home improvement project. Now you can create a prescriptive budget, which adjusts your current spending in a way that will allow you to reach your goals. Do not be afraid to shop around for deals. For example, if you plan to install a backyard pool, compare pool loans and determine who offers the best rates and terms. Be realistic with your budget, and balance sacrifices with rewards. Remember, reaching your financial goals is not only about math; it is also about motivation.

Pay Off Bad Debt

You incur bad debt when you borrow money to purchase anything that will not grow in value. Bad debt is sometimes necessary to purchase family vehicles or to replace broken kitchen appliances. Obviously, it is smart to minimize the amount you finance. Put as much money down as you can, and buy items gently used or on deep discount. Again, shop around for good rates on financing as diligently as you shop for the items themselves.

Typically, the worst kind of debt comes when you charge items to your credit cards. Cards that let you “earn” rewards may seem like a good deal, but be wary. Annual fees add up and interest rates are usually high. Often, by the time you pay off the card, you have forgotten most of what you bought. To save money, pay off all loans early, especially credit card balances. Send in the minimum payment plus at least $100 each month. Automate payments so that you are never hit with late fees or penalties.

Control Good Debt

In contrast, good debt results when the money you borrow ends up making a profit. Examples of good debt include most mortgages and student loans. Naturally, spending too much on any type of debt can turn a wise move into a foolish one. Mortgage payments should be 25% or less of your net income. Remember that in real estate, appreciation is not guaranteed. Be wise about education loans, too. Your total student debt upon graduation should be less than the estimated first year’s earnings in your chosen field. Once you have your bad debt paid off, put extra money toward these loans and pay them off early, too. Managing debt well from the start can save you a great deal of money and heartache.