Personal Finance / Unit 5: Credit and Debt
5.6 Managing and Avoiding Debt
Notes
Debt is manageable when payments fit comfortably in your budget.
- Debt-to-income ratio = monthly debt payments $\div$ monthly gross income. Example: $600 on $2,400 is 25%.
- Two payoff methods: avalanche (pay the highest interest rate first) and snowball (pay the smallest balance first for quick wins). Avalanche saves the most interest.
- Pay at least the minimum on every debt while you focus extra money on one.
- Be careful with payday loans: fees are very high. A $15 fee on a $100 two-week loan is 15% in two weeks, about 390% per year.
- Build an emergency fund so you are less likely to borrow in a pinch.
Practice
Debt A is $500 at 25% interest; debt B is $2,000 at 10%. Which should the avalanche method target first?
The avalanche method targets the highest rate first.
Monthly debt payments are $450 and gross monthly income is $1,800. What is the debt-to-income ratio?
$\displaystyle \frac{450}{1800} = 0.25 = 25\%$.
Why are payday loans risky?
Short-term fees translate to extremely high APRs.
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