You can use your money to take care of various things, but don't forget to first repay those who helped you out financially at one point in your life. This is what a good friend of mine, who is also an expert money manager, says. By reimbursing your debts, even if it means paying the bare minimum, you take effective steps, maybe baby steps, to repair your credit and get back on track, financially speaking.
There are various pros and cons to saving money or repaying debt, but you also can find a happy medium that protects your living standard yet allows you to improve your creditworthiness.
The Basics of Debt and Money Management
A debt management specialist helps you cope with your financial obligations, instilling in you the important notions of debt tracking, repayment, debt consolidation tips and, if needed, settlement. Your debts run the whole gamut, depending on your lifestyle, business aspirations, and past and current credit behaviors. Also known as liabilities, debts include credit card balances, student loans, car loans, mortgages and the tapped portion of home equity lines of credit, or HELOCs.
Money management takes a broader view of your finances, touching on things like debt, income, wealth management, expense reduction and estate planning. In essence, that practice takes a deep dive into your economic situation to figure out things you are doing right, areas where you need improvement, your debt-to-income ratio, and initiatives you should take to become debt-free and make more money in the future.
Don't take the debt repayment versus money management conundrum as a mutually exclusive proposition; it is not. You don't have to sacrifice your financial independence and cash position because you want to make lenders happy. Believe it or not, lenders – especially banks with a long-term perspective - would rather have a borrower with a substantial savings account because they can earn interest income and have peace of mind knowing that the debtor would make his or her debt payments on time.
Option 1 –Repay Debt
- You repair debt or improve your credit.
- Your credit score increases thanks to a lower debt load and the improvement in your creditworthiness.
- You can apply for a new personal loan or mortgage.
- You are viewed as a lower risk by landlords, lenders and insurance companies.
- You may not have a rainy-day fund for emergencies.
- With no cash at hand, you or your loved ones might be frustrated that you are taking care of past debts instead of spending money on present and future needs (think of how many relationships deteriorate because of financial and debt issues).
- Your credit might be reduced, albeit temporarily, because the top three credit bureaus – Experian, Equifax and TransUnion – take payment patterns into account to assign your FICO score.
Option 2 – Save Your Cash
- You have enough money to withstand an emergency.
- You can open a savings account, certificate of deposit or money market account and earn interest.
- You can invest the cash in financial products, such as U.S. Treasury bills, stocks and bonds.
- You have peace of mind – an important element that could prevent or mitigate the emotional toll and stress that come with too much debt.
- You have a low credit score, which may be in subprime territory (below 640), depending on your situation.
- You are viewed as a high risk by insurance companies, creditors and landlords.
- Your lenders – such as credit card companies – might increase your existing rates, given your increased risk (they typically monitor your account and review your credit file every month or quarter).
- You actually would be losing money if the interest you receive on savings accounts is lower than the annual percentage rate you are paying on outstanding loans.
- You would be paying a high interest if you apply for new loans – assuming your application is approved (it may not, given your status as a high-risk applicant).
I think it is best to use part, not all, of your money to repay debt, setting the remaining portion aside to build up a small nest egg that gradually will grow. Don't put all your cash eggs in either the same basket – be it the savings basket or the debt repayment basket. Finding a happy medium is important to your personal financial situation because the last thing you want is to live penniless and tell people you have a high credit score, or to be someone with a deep pocket but who is viewed as a high risk in major credit, real estate and insurance transactions.