Dealing with debt

The responsible use of credit allows you to buy things now rather than waiting until you’ve saved enough money to do it independently. For example, most people borrow by using credit cards for everyday purchases or by getting loans to start a business, buy a house or finance a car.

But too much debt can make budgeting feel like a straitjacket — and that is the opposite of what a budget should do. A good budget provides knowledge into your income and spending patterns, giving you more control, not less.

So how do you use credit wisely? First, it helps to know how much you can reasonably borrow, and what it’s going to cost you.

If you take out a loan, you’ll typically have a fixed-rate interest payment and a term, which is the number of years or months you’ll make payments. Those payments will generally be the same, month in and month out. And you’ll know the endpoint.

The APR, or annual percentage rate, tells you what the total loan will cost once other costs (application fees, origination fees, maintenance fees) are included. It doesn’t include late fees if you miss your payment due date, but it’s good to be aware of them.

Credit card debt

Your credit limit is the maximum amount you can borrow. But while you have some flexibility about how much to pay each month above the minimum payment, you don’t control the interest rate.

Credit card minimum payments are the amount you must pay to avoid late fees and penalty interest rates. The way they are calculated can depend on the credit card issuer. Keep in mind, paying the minimum payment might help with your budget, but it doesn’t help reduce debt quickly. 

Budgeting wisely is key.

Debt — credit card and loan balances — comes into play in a bigger financial picture when you compare it to income. This is known as your debt-to-income (DTI) ratio, defined by the Consumer Financial Protection Bureau as: “All your monthly debt payments divided by your gross monthly income.” The DTI can help determine how much money you can borrow and at what rate.

So, how do you keep your options open and your borrowing costs low?

Pay attention and own your plan. Keep an eye on your budget, your debt and your credit score. If you find you need to restructure your debt, a healthy credit score can help maximize your choices and minimize your costs. 

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