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So, what is debt management?
What is debt management depends on your current situation. Are you drowned in debt? Or are you beginning your professional career and looking for a nice fancy car? Let's see the differences:
What is debt management for people with high debts?:
If you have a lot of debts, debt management is a must being your obvious goal to reduce them.
What is debt management for people with little or zero debts?:
For people who have little or zero debts, debt management is a precious opportunity to learn how to use it correctly and not to struggle to pay debts in the future.
Of course people who had a bad experience with debt can learn too, but sadly their experiences are so painful that don't want to know about debts anymore and think that debts are bad by it selves and blame them for their "bad luck".
Debts are not bad by it selves but ignoring how they work is dangerous. Careful people with financial education can use them for their own benefit but people without education can be harmed badly.
Basics of debt management
What is debt management can be expressed in these basics aspects:
- Learn the difference between good and bad debts. We talked about this in our introductory article but is important to repeat this basic aspect.
- The longer your debt's term the higher the interests you'll pay. Did you know that if you borrow $100.000 at 6% for 30 years you'll end paying $216.438 in principal and interests? That's the effect to have a balance for a long time. What happens if we reduce the term to say just 20 years? You'll pay $172.660 a big difference indeed.
So why people borrow money for long terms? Simply because installments are affordable when you borrow for a long time.
- Debts are not only interests, be careful with "extra charges and fees". Sometimes financial institutions offer attractive interest rates but you have to be careful to ask (because they usually forget to tell us) if there are additional charges as forms or any fee to be considered in the cost of the loan.
- The better repayment history you have the better deals you'll get. If you're careful enough to pay your installments on time you can enjoy two benefits: better interest rates and the security that your payment is going to pay your debt and not paying penal interests.
The first benefit is easy to understand but the second is important to clarify: If your installments (agreed contractually within you and your borrower) are due each first day of month, that means that if you don't pay on time your borrower has the right to charge you a penal interest for not comply with the contract.
If you pay late sometimes is ok but you have to be conscious about what happens if you constantly do this.
Let's say your installments are $860 monthly and your loan contract says that in case of late payments a penal interest of 1% will apply.
pay on time your payment will be applied this way: $620 interest, $240 to principal.
If you pay just 1 day late
your payment will be applied this way: $640 interest, $4 penal interest, $216 to principal. So, you lose $24 to pay your debt. Why this happens? Because financial institutions always apply payments to repay interest first and then apply the rest to principal.
$24 is not a big sum of money indeed but if you compound this effect to constantly delays you'll get a bigger and sad surprise.
- Be sure your financial institution doesn't have penal interests for early payments. Considering the business of financial institutions is charge and collect principal and interests they don't like people who repay their loans early because they can't charge interest. So they invented a penal interest for early payments to secure their earnings.
I consider this is a huge damage for your finances because you're condemned to be a debtor for a long time. The effect is the same of the penal interest for late payments. Be careful with this type of loan's clause.
So, now that you know what is debt management...what could you do?
Borrow for the long term to have affordable installments but pay as soon as you can, make extra payments to principal. If you have a penal interest for early payments you should analyze the cost/opportunity to refinance that debt with another without that clause.
Pay on time and you will get good deals, you won't lose more money and the time that you'll be a debtor will be less.
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