For most people, borrowing money is a necessary part of life that can help them achieve important goals, like earning a higher education degree or buying a house. In situations like those, taking on debt can actually be a good thing.
"The trick in managing your debt is knowing how much you can take on," says Christopher Vale, senior digital director, Preferred Client Experience for Bank of America.
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Please see important information at the end of this program. Recorded on 02/29/2024.
[Christopher Vale speaking throughout]
Hi, I'm Chris Vale, with some guidance on managing debt.
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Managing your debt: How much is too much?
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Christopher Vale
Senior digital director
Preferred Client Experience
Bank of America
Not all debt is bad.
In some situations, like buying a home, taking on debt can actually be a good thing, especially if it's used as an investment in your future. But if you start accumulating balances on credit cards, only making the minimum payments and accruing interest, that's considered "bad debt."
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Good Debt vs. Bad Debt
It could also mean that you're spending more than you're taking in, and piling up debt that isn't supporting your long-term goals. So first, let's figure out how much is right for you.
The trick in managing your debt is knowing how much you can take on. One useful measure is your "Total Debt Service Ratio," which sounds complicated but is just a simple calculation.
You can just divide your combined monthly debt payments for things like a mortgage, student loan, car loan and credit cards by your monthly income.
Say, for example, your monthly debt payments total $3,000 and your income is $6,500.
Dividing 3,000 by 6,500 gives you a ratio of .46, or 46%.
Anything above 43% is generally considered an unhealthy level of debt.
[A vertical scale shows Total Debt Service Ratio from 35% up to 50%. A dotted line cuts the scale at 43%, and the label reads: "Above 43% considered unhealthy."]
With that ratio, your monthly payments may be interfering with your ability to meet regular expenses and pursue important goals like saving for retirement.
[A blue image of a wallet containing money is overlaid with a red X.]
Bringing that level down under 36% is considered ideal.
[A downward facing arrow appears to the left of the scale, with a dotted line cutting the scale. It moves downward and stops at 36%. The label reads, "Below 36% considered unhealthy."]
At this level, lenders could view you as a "good risk" because they see you as financially healthy.
What would that mean for you? First, it boosts your likelihood of getting approved if you need to borrow. Second, it could help you get a better interest rate. Big picture, you're most likely able to comfortably pay down debt while pursuing other goals.
So how can you limit your debt?
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Setting limits
There are a variety of ways, from choosing a home or car that suits your income, to shopping around for the best interest rate on loans. But the first thing you need to do is create a budget based on your monthly take home pay.
[A table appears on screen, with the title "Budget." The left column is labeled "Fixed Costs," and the right "Discretionary Expenses."]
Calculating your fixed costs for things like rent or mortgage, car payments, insurance and utilities can tell you how much money you have to spend on discretionary things like travel, dining out or concert tickets.
[Images appear in the Fixed Costs column as Chris says them: a house, a car, a shield and an electrical plug. Images appear in the Discretionary Expenses column as Chris says them: A plane, a knife and fork, and concert tickets.]
When you stick to it, your budget can help prevent overspending with credit cards, which often come with high, variable interest rates, making it difficult for you to pay more than the minimum from month to month, that's the "bad debt" trap.
After you've prioritized paying down your debt, you can turn your focus to balancing that effort with other goals, like saving for retirement and creating an emergency fund.
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Preparing for your future
Steadily contributing even small amounts to your retirement plan and earning a matching contribution from your employer, if offered, can make a big difference over time.
[An image of a piggy bank with money going into it]
And an emergency fund, could help you meet unexpected costs without having to take on additional debt or impacting your retirement savings. So, don't let debt worries consume you. Getting organized, setting specific targets and measuring progress along the way will help you take charge of your financial future and improve your financial wellness.
Watching this video is a great start. You can find more useful tips on budgeting, paying off credit cards and managing debt at
BetterMoneyHabits.com.
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Thanks, and best of luck to you!
On screen disclosures:
Important Disclosures
Investing in securities involves risks, and there is always the potential of losing money when you invest in securities.
Merrill Lynch, Pierce, Fenner & Smith Incorporated (also referred to as "MLPF&S" or "Merrill") makes available certain investment products sponsored, managed, distributed or provided by companies that are affiliates of Bank of America Corporation ("BofA Corp."). MLPF&S is a registered broker-dealer, registered investment adviser, Member SIPC popup and a wholly owned subsidiary of Bank of America Corporation ("BofA Corp.").
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