Debt Management Plan

An effective debt management plan is central to financial success. With good debt management techniques, you can save money on current interest expenses and improve your chances for securing credit on good terms in the future. As part of your financial plan, you must differentiate between good and bed debt. With this knowledge, you can best make strategic payments.

Good Debt Versus Bad Debt

Good debt is leveraged to purchase assets, goods, and services that generate additional wealth. Further, good debt typically features low, tax-deductible interest expenses. Examples of good debt would therefore include a mortgage alongside student and business loans. Alternatively, bad debt is associated with consumer spending that does not add value to your bottom line. For example, you may put vacation packages, designer jeans, and fine restaurant dining expenses on your credit card. Expensive interest rates on your charge card would further add to the costs of these consumer items. Through debt management planning, your goal remains to keep bad debt to a minimum.

Your Credit Report

You should order a copy of your credit report to help you to organize debt balances according to size, type, and payment history. You should also check your credit report regularly for errors, which may be a sign of identity theft and fraud. False information on your credit report will subject you to unreasonably high interest and rejection rates.

You may order one free credit report each year through AnnualCreditReport.com. At any time, you can also purchase your credit report and score from Experian, Equifax, or TransUnion. Each agency does provide online resources that help you to dispute incorrect information on your credit report.

Refinancing

After receiving your credit report, you should contact all of your lenders and attempt to negotiate lower interest rates. To keep your business, a lender will be more likely to offer lower interest rates if you have demonstrated a proven track record of making timely payments. If a current lender is not willing to lower rates, you can refinance by taking on new debt and using the cash proceeds to pay off the old loan. The goal with refinancing is to effectively cheapen the carrying costs of your debt, overall. For large loans, such as a mortgage, refinancing will introduce closing costs that are generally 3 percent of your loan principal. As a good rule of thumb, you should refinance a mortgage when you can lower your interest rate by more than 1 percent and plan upon owning the associated property for at least the next ten years.

Analyze Sources of Cash

As part of your debt management plan, you will analyze your current finances to locate sources of cash that can be directed towards making payments. To raise cash, you should sell off under performing investments whose returns do not exceed your interest charges. For example, you should liquidate a $10,000 bond portfolio that generates 5 percent annual returns, if you also carry $10,000 worth of credit card debt at a 20 percent interest rate. In terms of cash reserves, funds above six months worth of living expenses can be withdrawn to make debt payments. For affordability, you can spend 36 percent of your gross income on debt payments on a regular basis.

Strategic Payments

You will prioritize making strategic debt payments according to interest rates. To do so, you will make the minimum payments on all debt balances -- to preserve cash for the most expensive balance. Once your most expensive debt is paid off, you will then turn your focus to the balance with the next highest interest rate.

Debt Management Plan, Sources:

Experian: Credit Report FAQ

Federal Trade Commission: Knee Deep in Debt

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