What you need to know about paying down debt

Which is more important: paying off debt or saving for the future? If you already have a significant amount of debt and not a lot in savings or investments, it can be hard to figure out which should be a priority. In this article, we discuss how to pay off debt while still setting yourself up for a financially sound future.
Yes! Loans, when used properly, enable a lot of life’s milestones. Buying a house, paying for college and even buying a car are all examples of how incurring some debt in the short term can actually increase your potential net worth down the line. As you think about paying down your debt, keep in mind that not all debt is created equally — and, therefore, should not be paid off in the same way. The table below describes some general characteristics of good versus bad debt.
Good debt | Bad debt |
---|---|
It has a low interest rate, and it’s a bonus if the interest is tax deductible. | It has a high interest rate. |
It’s used to buy something that has value, may increase in value or will help generate income. | It’s used for something that doesn’t have future value. |
It doesn’t push your total debt levels too high. | It pushes your total monthly loan payments (not including your mortgage) to more than 20% of your monthly income. |
To know if you have too much debt, you first need to assess the debt you currently have. Take note of balances, interest rates, monthly payment amounts, when it’s expected to be paid off, tax deductibility and any other important features. This sounds simple, but we know it can be overwhelming. Feel free to take it a small step at a time until you’ve compiled the critical information about all your debt.
Next, you need to determine your debt-to-income (DTI) ratio. To calculate your DTI ratio, divide your monthly required debt payments by your gross monthly income. If you’re paying a mortgage, try to keep your DTI ratio at 35% or less. (Without a mortgage, strive for 20% or less.)
Your debit-to-income (DTI) ratio can be a great predictor of your financial health. The higher the number, the higher the percentage of income being used to pay off debt. If you have a higher DTI ratio, you may struggle to make ends meet, have trouble securing loans for big purchases such as a home or may be forced to accept higher interest rates on those loans.
It depends on the type of debt you have and what you currently have saved. Paying off your debt as fast as possible may seem like the responsible thing to do, but not having an adequate emergency fund or saving for your future could leave your finances at a permanent disadvantage down the road.
Here’s how we suggest you prioritize paying off your debt without sacrificing your other financial goals:
To make achieving these goals easier, automate as much as you can. For example, you can divert part of your paycheck into an emergency savings account or a retirement account and set up automatic payments for any debt.
While it may seem like a huge endeavor to pay off your debt while still saving for the future, it doesn’t have to be. Taking small, incremental steps is key to getting to where you want to go. Plus, your financial advisor is always here to help you put together a strategy to help you achieve your financial goals based on your unique needs and circumstances.