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How to Manage Debt
- Written by:
- Baylor Cox
- Reviewed by:
Going through life without any debt is nearly impossible. Most Americans have loans, and many college students typically graduate owing tens of thousands of dollars in student debt. According to a 2024 report, debt balances are up across the board, with credit card debt up 10% from the previous year.
Being in debt is certainly no fun, and it can sometimes take over your financial life. For a lot of people, debt can make it hard to cover even everyday living expenses — not to mention saving for retirement or other financial goals.
As stressful as debt can be, some debt can actually be a smart financial tool. Here are two key things to consider when deciding whether or not you should take on some debt.
Determine how much debt you can afford
The key is to take on only as much debt as you can easily afford to repay. Know how much disposable income you have each month (after accounting for all regular bills and necessities), and make sure not to take on debt payments greater than that amount. You should always keep about 3–6 months of expenses in an emergency fund in case you incur an unexpected expense.
Know the difference between good debt and bad debt
Bad debt is high in interest and used to buy something you don’t need and that is unlikely to retain its value over time. Buying the latest trendy gadget or splurging on designer clothes are typical examples.
On the other hand, good debt carries low interest and is used for something that is likely to appreciate in value or help improve your financial position. Taking out debt to buy a house, go back to school, or purchase a car you need to get to work are some examples.
How do you determine if it’s okay to take on debt for a purchase?
Here’s a checklist to help guide you:
• You are buying something that is likely to grow in value or improve your earning ability
• You can handle the monthly debt payments easily
• You have an emergency fund in place
• You are already saving regularly for retirement
• You aren’t overpaying for the item you are buying
• You’re able to get a competitive interest rate for the loan
Understanding and Managing Your Credit Score
Knowing your credit score is critical to helping you manage debt. A lower score can keep you from qualifying for a mortgage (or a more competitive interest rate) and could mean much higher interest rates on new credit cards. Knowing your score — and what is involved in calculating it — can help you build better credit.
Each major credit bureau in the U.S. (Experian, TransUnion, Equifax) can calculate a credit score for any borrower applying for a loan. If you’ve ever applied for a loan of any kind, chances are you recognize at least one of these names.
Credit scores are three-digit numbers that can range from a low of 300 to a high of 850. In general, a score of 680 or higher is considered excellent. And while the scores can vary by credit bureau, they are mainly calculated based on these five factors:
• Payment history — whether or not you pay your bills on time or at all. To maintain a good credit score, make sure you pay your bills on time!
• Total outstanding debt — how much you owe right now. To maintain a good credit score, make sure your credit card balance is no more than 25% of your available credit. For example, if you have a card with a $10,000 credit limit, keep your balance at or below $2,500.
• Credit types — the mix of debt you have now. Successfully managing a variety of loan types can help raise your credit score. Lenders will see you as a more experienced borrower if you have, for example, a mortgage, a car loan, and a couple of credit cards. If all you have is credit card debt, you’ll be considered less experienced and score lower.
• Length of credit history — how long you’ve had credit. The longer your track record of maintaining good credit and paying back loans or credit cards, the better your credit score will be.
• Credit applications history — the number of times you’ve tried to get credit (whether or not you were successful). You should avoid opening several new accounts just to take advantage of special offers like airline miles or cashback. Having too much available credit can actually make you look like more of a credit risk.
It takes time and discipline to improve your credit score — sometimes a few years. But by paying attention to these five components of your credit score and managing your credit responsibly, you can maintain ideal debt management and improve your overall financial health.
Your Debt-to-Income Ratio: An Important Financial Tool
Calculating your debt-to-income ratio — or DTI — is a great way to check that your level of debt falls within an acceptable range (or not). Your DTI is a percentage calculated by dividing your total recurring monthly debt by your monthly gross income.
[Monthly Debt Payments] ÷ [Monthly Gross Income] = DTI%.
| Example | |
| Minimum Monthly Debt Payments | |
| Mortgage or rent payment | $1,300 |
| Car loan or lease payment | $400 |
| Credit card payment | $300 |
| Student loan payment | $200 |
| Total | $2,200 |
| Gross monthly Income | |
| Salary | $3,000 |
| Spouse/Partner’s salary | $4,000 |
| Total | $7,000 |
| DTI: $2,200 ÷ $7,000 = .314 | 31.4% |
Once you’ve calculated your DTI ratio, you’ll want to understand how lenders view it when considering your loan application. Guidelines can vary widely by lender, but here are some general guidelines used by Wells Fargo, one of the largest mortgage lenders in the U.S.:
35% or less: Looking Good
Relative to your income, your debt is manageable. You most likely have money left over for saving or spending after paying your bills.
36% to 49%: Opportunity to improve
You’re managing your debt adequately, but may want to consider lowering your DTI. This could put you in a better position to handle unforeseen expenses. If you’re looking to borrow, keep in mind that lenders may ask for additional eligibility criteria.
50% or more: Take Action
With more than half your income going toward debt payments, you may not have much money left to save, spend, or handle unforeseen expenses. With this DTI ratio, lenders may limit your borrowing options or refuse to lend to you.
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