Money BasicsBorrowing & Credit

Expert tips on how to manage debt wisely

When it comes to money, it’s difficult to talk about debt. Many Filipinos have bad experiences with debt, whether they’re the ones lending or the ones borrowing. Many are caught in a cycle of debt due to irresponsible financial management, predatory lenders, or a combination of both.

But debt doesn’t have to be scary. You just need to know the right types of debt to incur and how to manage them properly.

How to manage debt

When managed well, debt can improve your productivity and quality of life. Save yourself from the vicious cycle of debt by following these six rules:

  1. Never borrow to invest
  2. Using your credit card wisely as a financial tool will increase productivity or quality of life.
  3. Manage your credit card debt right away.
  4. Borrow only from credible institutions.
  5. Always know your risks and responsibilities when you take on debt.
  6. Make sure you’re financially stable so you can afford the terms of payment.

There are two kinds of debt, good and bad. Understanding the difference between good debt vs. bad debt spells the difference between using debt to improve your quality of life and being trapped in a vicious cycle. Good debt can help improve your quality of life, provided you don’t go overboard with it.

Let us discuss in depth the rules on how to manage debt effectively:

Never borrow to invest

First, it’s important to understand that investing means using your money to purchase assets that grow in value over time. Investments like stocks and bonds have different levels of potential for growth. However, they all have one thing in common: uncertainty. In general, the higher the uncertainty, the higher the potential for growth.

On the other hand, debt is very predictable. No matter what happens in the stock market, if you have a loan, you have to pay your dues. Running a race between the interest on your loan and the growth of your investment is an almost surefire way to lose money. This is why you do not borrow money so you can make an investment.

Instead of borrowing money to invest, it would be better to save up and build an emergency fund, before you even think about investing. Once you have put enough money into a sizable emergency fund, you can then start putting money towards investing instead.

Using your credit card wisely as a financial tool will increase productivity or quality of life

Before you borrow money, ask yourself where the money will go first. Whether it’s a loan or purchasing something with your credit card (yes, your credit card balance is debt), always make sure you’re using it for something that benefits you.

For example, you take a home loan to purchase a condo unit near a business district area. While it may be expensive, it also provides several benefits. Chances are that your employer is in the business district. Living near your place of work takes away the stress of commuting, especially if you can walk to your office. Besides spending less on transportation, you also do not have to spend as much time commuting. This gives you more time for rest and recreation, thus greatly improving quality of life.

But what if you don’t have to work onsite? Here’s another example: you purchase a brand new laptop using your credit card’s installment plan so you can work remotely. With a stable internet connection, you can be productive and do your housework alongside your job. On top of that, you spare your savings from having to shell out a lot of money for a single payment.

Managing your credit card debt right away

Don’t be afraid of using your credit card, especially on essential goods. It builds your credit history, which tells banks you are responsible when it comes to debt. If you have a record of managing your credit card well, banks are more likely to approve your loan applications in the future.

You want to make sure you pay off your credit card bills every month, so you don’t accumulate any late fees or interest rates, as these compound the longer you fail to do so.

If you do find yourself with unpaid credit card bills, develop a system to pay them off. Start by computing for how much you owe each credit card company. Once you have a breakdown of your debts, focus on paying off the debt with the highest interest rate first. Once you’ve successfully paid this off, move on to the next one with the highest interest rate. If the interest rate on your debts are all the same, start with the biggest debts first. Either way, the idea is you want to minimize the growth of interest.

Borrow only from legitimate and credible institutions you trust.

The promise of quickly getting cash for things you want is always tempting, and many lenders take advantage of this. Some lenders claim you can borrow money in a matter of hours, with just a government ID as a requirement.

Always be skeptical. Borrowing money has a cost, be it in interest or a collateral. That’s why you should only trust established institutions with proven accountability.

Institutions such as banks, government institutions, and lending companies have reputations to protect. They may be slower in lending money, but it’s because they take the time to gauge if you have the capacity and the ability to pay back the debt. While this due diligence protects them from bad debtors, it also prevents you from taking a loan you can’t afford.

Read Up: How to source emergency cash in the time of COVID-19

Always know your risks and responsibility when taking on debt.

Having debt is something you must live with over a long time, so make sure you know what you’re getting into.

Understand how much interest, plus any penalties, you must pay if you miss a payment, and if the interest rate changes at some point. Check if your interest is charged on specific periods, like monthly or annually. If it requires collateral, be aware that there are many scenarios where you may lose it. The last thing you want is to pay for a house or a car that’s taken away because you default on your debt.

Make sure you have a stable and regular source of income so you can afford the terms.

Once you’ve done your due diligence, check if you can pay back the loan. Ask yourself if you can afford the monthly amortizations. Make sure you have a stable source of income such as regular employment or a profitable business. If you lose your job, what are your options? Will you still have a means to pay, or will you be forced to use your savings or emergency fund? If you default on your debt, are you willing to cash in investments? As negative as this sounds, it’s better to imagine the worst now, so you can prepare for any contingency. One way you can save money to pay back your loans is by learning how to live a frugal life.

Learn more about home loans, car loans, and other ways to upgrade your quality of life by visiting our website.

This article is part of a collection of stories and practical financial tips that are published with the goal to help people learn from the experiences of others, and to pick out lessons on personal finance and sound money habits beyond the pandemic.