Americans are working hard to reduce individual debt burdens. In some cases, unfortunately, we are simply swapping one liability for another, data from the Federal Reserve show—cutting, say, credit card debt while adding education debt. Still, overall our burden is in decline. Consumers have cut debt by $100 billion in less than a year, according to the Federal Reserve Bank of New York.
That’s undeniably positive for the personal balance sheets of millions of households. But too often families that cut debt feel they’ve done enough. It’s equally important to manage what debt remains. On an obvious level, that means continuing to pay off loans in a timely way—targeting the highest rates first and not lapsing into unnecessary credit spending.
But there is much more to consider, says Consumer Advocate Eleanor Blayney at the Certified Financial Planner Board of Standards. She offers five keys to family debt management:
- Match assets and liabilities. This is a Cardinal rule at banks, pension funds and insurance companies. It’s also the idea behind target-date mutual funds, which gradually move from stocks to cash over a period of years when you are saving for college or retirement. The idea is to have assets available at the time you’ll need them. So avoid financing a long-term asset, such as a home, with a short-term loan from a credit card. You can’t use the value of your home to pay the bill. Borrowing long-term for a short-term asset spells trouble too. If you take a 10-year loan for a used car you’ll still be paying long after the car is in the junkyard.
- Maintain liquid savings. It’s not always possible to perfectly match assets and liabilities. That’s when it becomes tempting to dip into liquid savings. Refinancing your mortgage at a lower rate is a smart move. But you may need to dip into savings to pay out-of-pocket closing costs—a good idea only if you can immediately begin rebuilding your liquid savings.
- Watch interest rate risk. If you borrow at a variable interest rate the cost of your loan will rise as market rates go up. That hasn’t been a problem in recent years, as rates have mostly fallen. But the trend will reverse eventually. So plan for higher loan costs down the road.
- Don’t forget to save. Paying off debt is great. But if you are cutting debt at the expense of socking away retirement savings you will end up disappointed years from now. It may be wise to pay down your debts more slowly and max out saving in a 401(k) plan, especially if that plan offers an employer match.
- Minimize regular debt expense. Most debt must be serviced each month. Thus, it becomes an unavoidable regular expense. The larger such expenses are, the less flexibility you have. This is a key point for retirees, who may be living off their investment portfolios and be forced to sell stocks when they are low just to keep current on their debt obligations. So it may be wise to eliminate debt—even while loan rates seem favorable.