Many of us know that setting financial goals and creating budgets can help us manage our money. However, it’s also important to manage your debt. Most Americans are carrying around at least one credit card, and the average balance on a credit card is just under $6,200.
When you add one or more credit card balances to other debt, like a car loan or mortgage, you may find yourself in a situation where it becomes difficult to keep up with your bills. While it may seem like an option to pay less than your minimum payment or to skip a bill altogether, those actions can have serious consequences. When your debt has gotten beyond your control, debt management can help you get back on track.
What is debt management?
Debt management is a way to get your debt under control through financial planning and budgeting. The goal of a debt management plan is to use these strategies to help you lower your current debt and move toward eliminating it completely. You can create a debt management plan for yourself or go through credit counseling to help you with your plan. There are both for-profit and nonprofit credit counseling organizations. While these organizations operate in different ways, they operate with the same goal: to help people come up with a budget to pay off their debts and manage any new debt they may create.
How does debt management work?
Debt management plans are meant to address unsecured debts like credit cards and personal loans. They can work in one of two ways. The first way is a DIY version of debt management. In this version, you create a budget for yourself that will allow you to pay off your debts and maintain your financial stability. You can use budget calculators, repayment calculators and financial management apps to help keep you on track. If need be, you can also do some negotiating with your creditors to try and lower your monthly payments or interest rates to help you decrease your debt. Once you have gotten the debt under control, you can decide if you want to keep or close an account.
The second form of debt management is to go through credit counseling. You can find a credit counselor in your area through the National Foundation of Credit Counselors. A credit counselor will help you come up with a plan to repay your debt, and can also negotiate a payment plan with your creditors. This payment plan is meant to help you eliminate your debts. Depending on your circumstances, your credit counselor may close your accounts as each debt is paid off, to avoid creating any new debt.
Is debt management right for you?
Debt management can be a very helpful tool for releasing debt, but it isn’t a magic bullet. For starters, debt management doesn’t address secured debts like mortgages. Another important thing to note is that debt management doesn’t stop your bills from coming. In order for debt management to work, you will need to have enough income to cover your existing bills.
A debt management counselor may be able to negotiate a lower monthly payment or interest rate, but the bills will still have to be paid on a regular basis. And missing a bill is not an option. Not only will it have a negative impact on your credit score, but it may also cause your creditor to cancel your negotiated repayment plan. This will leave you back at square one with your debt.
Does debt management affect your credit score?
While debt management can be a helpful tool to get debt under control, it can have negative effects on your credit score. For starters, if you are attempting to get a lower interest rate, you may trigger a hard inquiry into your credit report. Hard inquiries stay on your credit report for two years and can impact your credit score for one year. However, this is a short term effect and can easily be countered by other factors. For example, if you are able to get your rate lowered, and this means you’re able to pay your monthly bill consistently, you’ll see a positive effect on your payment history, which makes up 35 percent of how your credit score is calculated.
While consistent payments will have a positive effect on payment history, missing payments will cause your credit score to lower significantly. If you, or your credit counselor, are using a tactic of withholding payment from your creditor to get a better rate, expect your credit score to go down.
Another key factor in the health of your credit score is your credit utilization. This factor makes up 30 percent of how your score is calculated and is linked to how much debt you carry compared to how much credit you have available. The ideal credit utilization is between 10 and 30 percent. This means that your debt should equal no more than 30 percent of your available credit across all accounts. If your debt has gotten past that, your credit score will suffer. However, making strides to pay debt off has a positive effect on credit utilization. That effect is maintained by keeping your credit card balances at or below 30 percent of your available credit.
One last thing to be aware of when managing your debt is the effect of debt consolidation on your credit score. Having all of your debt consolidated to one bill can be very beneficial for paying things off. However, if you close some of your accounts you’ll affect your credit mix, which makes up 10 percent of your credit score, and your credit history, which accounts for 15 percent.
Other financing options to handle debt
When thinking about how you will handle your debt, it’s important to choose an option that works best for your current financial situation. You can also use a variety of options together to tackle the problem. Debt management is one way to handle debt, but there are other options worth considering, such as balance transfer cards and personal loans.
Balance transfer cards
Balance transfer cards can offer you the ability to move your debt to a zero percent introductory interest card. This will give you the option to pay off your debt without having to worry about interest. Balance transfer cards do, however, come with fees, including a fee for each balance transfer in most cases. And if you are not moving your balance to a preapproved card, you may have to deal with a hard inquiry into your credit report.
Balance transfer cards are available if your credit score is in the good-to-excellent range, but may not be available if your score is in a lower range. You’ll also need to have a clear plan for repaying your debt before the zero percent interest period ends, because then you’ll be subject to the regular variable APR on any remaining balance.
Personal loans give you the chance to receive a lump sum of money that can pay off your debt all at once. A personal loan is a good option if you know that you will need more time to get your debt under control. Personal loans will offer a repayment period that typically ranges from two to seven years. While personal loans do have a longer repayment period, the repayment period is finite. This means that, unlike a credit card, you will have to repay your loan in the specified time period.
Your interest rate for a personal loan will depend on your credit score. Interest rates for personal loans can range from 5 to 36 percent, so it’s important to make sure that the rate you receive is lower than the rate you are currently paying on your card. Bankrate has a tool that can estimate your interest rate for some of the top personal loans on the market.