We all carry
some form of debt -
here’s how to make
it work for you
Debt has a bad reputation. And to be sure, too much of some debt is not something you want to be saddled with. But the truth is most of us carry some sort of debt throughout our lives, and that’s not necessarily a bad thing. In fact, some debt can benefit us, especially when it’s used to pay for something that has lasting value.
You may leverage debt to help you cope with and pull yourself out of a sudden life crisis, like a medical emergency, severe weather event, or an accident.
Debt can also help you when you’re buying a home. The amount of debt you have impacts your credit score — about 30% of your overall score is based on accounts owed — which can impact your ability to buy a home. Perhaps most importantly, when it comes to home ownership, your debt-to-income ratio is a key factor that lenders consider when reviewing mortgage applications.
So how can you make your debt work for you? The key is understanding favorable debt, where your debt comes from, and most importantly, how best to manage it.
As mentioned above, most of us have debt. Most of us need at least some debt in order to build credit and increase our net worth and earning power. Good debts are the things that do exactly that — business loans and mortgages that can grow in value and/or enable us to build wealth over a period of time.
Of course, one of the best ways to manage debt is to avoid bad debt whenever possible. That’s why it’s vital to evaluate your income, your expenses, and your goals and set up a budget that can provide for you and your family far into the future.
Amount of outstanding debt
Bill-paying history
Number of loans or accounts
How to Manage Debt
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Whether you have had a debt collection, foreclosure, or bankruptcy
New applications for credit
When it comes to buying your own home, managing your overall debt is crucial. Not only will reducing debt help you keep making those monthly mortgage payments, not to mention staying on top of utility bills and general upkeep, but positioning your debt relative to your gross monthly income is key when it comes time to buy a new home.
This is called debt-to-income ratio (DTI). In short, your DTI is your total monthly debt divided by your gross monthly income. Any lender that would give you a loan to buy a house is going to first look at your DTI when considering whether you are able to afford the monthly mortgage payment.
For more information about debt management and its impact on your credit, go to www.fanniemae.com/crediteducation.
On the other hand, bad debts are the amounts we owe on things that don’t improve our overall financial picture. These include the balance you carry on credit cards, car loans, and especially high-interest debts like personal loans and short-term payday loans.
When you sit down to make your household budget, taking a hard look at how much money you make and how much you spend, one of the first things you want to do is find ways to pay down bad debt as soon as possible.
There are only two ways to improve your DTI. One option is to increase your monthly income — but of course, that’s easier said than done. On the other hand, reducing monthly debt is something that is far more controllable for most of us.
There are several basic ways to decrease your debt. First, avoid taking on more debt. Put off any major purchases that aren’t essential. Next, consider ways to pay down the debt you have, starting with the bad debt like credit cards, personal loans, and car loans (The Consumer Financial Protection Bureau (CFPB), a government agency responsible for safeguarding consumers in the financial sector), lays out several ways to best reduce your bad debt.)
Of course, one of the best ways to manage debt is to avoid bad debt whenever possible. That’s why it’s vital to evaluate your income, your expenses, and your goals and set up a budget that can provide for you and your family far into the future.
How to Manage Debt
When it comes to buying your own home, managing your overall debt is crucial. Not only will reducing debt help you keep making those monthly mortgage payments, not to mention staying on top of utility bills and general upkeep, but positioning your debt relative to your gross monthly income is key when it comes time to buy a new home.
This is called debt-to-income ratio (DTI). In short, your DTI is your total monthly debt divided by your gross monthly income. Any lender that would give you a loan to buy a house is going to first look at your DTI when considering whether you are able to afford the monthly mortgage payment.
For more information about debt management and its impact on your credit, go to www.fanniemae.com/crediteducation.
Even people who regularly check their credit score might not know exactly what it is or what it really means. And if you want to know why that number is important, it helps to understand how it’s established and built.
Simply put, your credit score is a predictor of how likely you are to pay back a loan on time. Independent agencies, called credit bureaus, gather information from a wide variety of creditors — from public utilities to banks to credit card companies — and they compile it into your credit report. A typical report includes things like: