Get a Handle on Your Debt

A new year is a traditional time to take stock of every facet of your life and to make New Year’s resolutions related to health, family, personal goals and more. It is also a good time to review your overall financial situation. Are you:

· On track to meet your goals?

· Generating enough income?

· Managing expenses well?

· Saving enough for retirement and other long-term goals?

· Satisfied with your investment portfolio?

· Aware of how much debt you carry, and the cost of this debt?

· How do you know if you have too much debt?

Key Indicators of Too Much Debt

· Your overall debt is not going down despite making regular payments.

· You live paycheck to paycheck - with no excess money at the end of each month.

· You cannot contribute to an employer-sponsored retirement plan due to cash flow constraints. · You have not been able to build an emergency fund to buffer against financial shocks.

· You rely on credit cards for cash advances.

Do You Know How Much You Owe?

· Check your credit reports regularly through one or more of the three consumer credit bureaus: Experian, TransUnion and Equifax. View your reports regularly – up to weekly – through AnnualCreditReport.com.

· Review every debt account listed on the reports. The "Accounts" section lists all credit cards and loans in your name, including account status (such as "current" or "past due"), credit limit or original balance, and term.

· Create a record of your debts using a spreadsheet or a notebook. Note the lender, current balance, interest rate and monthly payment due date, plus the original balance and final payoff date.

· Confirm you recognize all the accounts on your credit report. Credit reports often have errors. If you did not open an account that is listed on your report, it is possible that someone opened an account in your name. Contact the lender right away to figure out whether you've been a victim of identity theft.

· Determine your “debt to income ratio.” Add up your monthly debt obligations (auto loans, housing payments, credit cards, student loans, etc.) and divide by your monthly gross income. If the debt-to-income ratio is less than 36%, your debt load is within the range considered affordable compared to earnings. If it is higher, in most cases you should take action to reduce your debt load. This will also help determine if you can afford to take on more debt – for a mortgage or auto loan, for example.

Prioritize Debt Payments in your Budget

Make a list of all your debts, including interest rates and balances for each. The two debt repayment methods below are popular approaches. Both require consistency. Set up automatic payments to ensure you never miss a due date to avoid late fees and additional interest. Regularly review your debt repayment plan to help you stay focused and track your progress.

1. Debt avalanche method: Make minimum payments on all your debts while paying any extra money toward your highest-interest debt until it's paid off. This helps reduce your debt burden more efficiently. High-interest debts, such as credit cards, usually take precedence over lower-interest

debt because they accumulate interest quickly and are more expensive over time. Focus on the highest interest debt first to reduce the total interest paid so you can potentially pay off debt faster.

2. Snowball method: Pay off smaller debts first to provide quick wins and build momentum in reducing your debt burden. This psychological boost can motivate you to continue paying off larger debts.

Pay Bills on Time

It is crucial to pay every bill on time. Even one late or missed payment can negatively impact your credit. Set up automatic payments from your bank account to ensure you pay at least the minimum required payment each month. Get into the habit of paying down credit card balances as much as possible to prevent charges from building up to the point that your debt is out of control. On time payments will also improve your credit score, or FICO score, which tracks payment history. The more often you make on-time payments toward your accounts, the higher your score.

Pay More than the Minimum Due

Paying more than the minimum due is effective for eliminating debt because paying only the minimum due keeps you in debt far longer. Minimum payments primarily cover interest, with only a very small portion applied to reducing the principal balance. If you pay more than the minimum, you will directly reduce the principal, thereby reducing the amount of interest you owe over time. This can save significant amounts of money in interest charges. If possible, allocate a portion of any extra cash (tax refund, bonus, raise) toward your debt repayment.

Limit Outstanding Balances

Another important factor in your FICO® Score is the amount of debt you owe, which also includes the amount of credit used in comparison to your credit cards' limits (“credit utilization”). For the most benefit to your credit scores, keep balances as low as possible. Credit scores can be negatively affected more significantly as your utilization approaches and climbs above 30%. A lower balance relative to your credit limit positively impacts your credit utilization ratio. This improved credit score can lead to better interest rates on future loans and credit products, minimizing your debt burden in the future.

Use Credit Cards Strategically

A credit card can sometimes be a smart way to finance a purchase, particularly if your credit card allows you to collect rewards. “Cash back” or travel credit cards may give you a statement credit or travel miles for every dollar you spend. Choose a card that provides rewards on your biggest spending categories, like groceries, gas, dining out or entertainment. However, carrying a balance and paying interest on the card will eradicate those benefits. Beware of annual fees for certain cards. Select a rewards card only if you're confident you can pay off your balance each month.

Carefully Consider Taking on New Debt

With any type of debt, there's the risk that you won't be able to make a payment on the account and wind up with a late payment or, at worst, a defaulted account. This can damage your credit score, making it harder to borrow in the future. If you are unsure you can make debt payments as agreed, postpone applying for a new credit account. Consider using your credit card only for occasional purchases you have to finance, like a new computer that you don't have the savings to cover. Or use your rewards credit card for specific purchases you'll get cash back or points for, then pay off the whole balance each month. When considering an installment loan, calculate exactly how much the monthly payment could burden your budget.

Build an Emergency Fund Creating an emergency fund is a crucial step to maintain financial stability and to keep up with debt payments even during unexpected situations. An emergency fund acts as a financial buffer, providing a safety net for unforeseen expenses such as medical emergencies, car repairs or sudden job loss. By setting aside savings, you can avoid missing debt payments and prevent you from taking on more debt. We typically recommend at least six months’ worth of living expenses in your emergency fund. Consider setting up automatic contributions to a dedicated savings account to build your emergency fund without having to think about it. Look for ways to reduce discretionary spending and direct the savings toward your emergency fund.

Debt management can be very challenging. It is an ongoing process that benefits from regular review and adjustments. If you have questions about this topic, reach out to a financial professional. If you are not currently working with FPS, we would be happy to talk with you. Questions? We are here to help.

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Best regards,

Janet Rhodes Friedman, CFP®, CDFA®, MBA

Janet@PlanWithFPS.com

617-630-4978

Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.