How to Find Your Optimal Debt Level
The new rules of debt management are more complicated than "good" and "bad" debt
In the wake of the recession and mortgage crisis, it's easy to forget that all debt isn't bad. In fact, in certain situations, taking on debt can be a good thing. Student loans and, in some cases, using credit cards, can catapult a person into the next stage of her career.
Meanwhile, exposure to the dark side of debt, including fees and interest payments, can be limited through careful management. Making debt work for you instead of against you just requires some advance planning and a little research.
Here's a guide to figuring out how much debt to hold onto to -- and when to get it off your back:
How much is your debt costing you?
Make a list of all your debt, along with the interest rates you're paying. For each entry, multiply the total debt by the rate to figure out how much it's costing you each year. If you have
Next, take a look at the rest of your money. Given the relatively low interest rates on savings accounts and even money market funds, you can probably save money by paying off any high-interest rate debt with savings. For example, paying off that car loan gives you an automatic 6 percent return on your money.
The decision to pay off debt is also influenced by other goals. If you plan to make a major career change or buy a house soon, then you probably want to have more cash in the bank. Holding onto the lower-interest debt, such as the student loan debt, might allow you to save more for those goals.
What kind of debt should you have?
While student loan debt tends to come with lower interest rates than credit card debt, generalizations don't always hold up: Not all student loan debt is "good" debt, and not all credit card debt is "bad" debt.
Student loans are also more complicated than they appear at first glance. They can be some of the cheapest forms of debt, especially when they're subsidized by the federal government. But the growth of the private loan industry in recent years means that many students graduate with some of their loans locked into interest rates that are over 10 percent, which can make them as toxic as credit card debt.
To make matters even more complicated, explains
When should you pay it off?
Forget the old rules about what's "good" debt or "bad" debt, and look at each of your loans separately. How much are they costing you? Could the interest rate suddenly spike? Pay off the expensive ones -- or the ones that could become expensive -- as soon as possible. While Ulrich's credit card debt helped get her started in the workforce, she paid it off as soon as she could by focusing on the highest interest-rate debt first.
Living a debt-free life
Gregory Go, 33, co-founder of the personal finance site wisebread.com, started living debt-free after paying off the
He makes do with a 15-year-old Honda Civic and lives with a roommate outside of
While he's had inklings of jealousy in the past, he says he'd still rather live debt-free than be in their situation. For Go, calculating his optimal debt level is easy: It's zero.
This article is adapted with permission from
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