How to manage debt: tips to improve financial wellness

What is debt?

Debt is any money that you owe to someone else, typically because of borrowing to finance a purchase or cover expenses. Debt comes in various forms, including credit card balances, student loans, mortgages, and personal loans.

For most people, debt is a necessary tool to help cover life's big expenses, whether you're purchasing a home, paying for college, or financing a new car. But it's important to understand how different kinds of debt work, especially when it comes to interest rates—which are the primary determinant of the cost of borrowing.

Before taking on a new debt, it's best to consider whether you really need to borrow—and avoid borrowing for unnecessary purchases, like luxuries.

When you need access to credit, explore lower-interest options first. Average interest rates on personal loans and home equity lines of credit (HELOC) tend to be much lower than interest rates on credit cards or payday loans—which are typically double digits or higher.

High-interest debt can accumulate quickly, due to the monthly interest charges. Interest charges on debt compound by adding the interest to the principal amount you owe, so you end up paying interest on the interest. And as your overall debt load adds up, it can take longer for you to pay off.

 I think it’s clearer and more accurate to say that interest rates are the primary determinant of the cost of borrowing (since there are also fees that could add up and, on a short-term loan, end up costing more than the interest charges).

Determine your debt payoff strategy

There are 2 common approaches to paying off debt: avalanche and snowball.

Debt avalanche method

This strategy prioritizes paying off your debt with the highest interest rate first, while continuing to make the minimum payments on all your other debts.

Once your highest-rate debt is paid off, transfer your payments to your second-highest-rate debt until that loan is also paid off. Continue until you've paid off all your prioritized debts.

This strategy aims to minimize your total interest paid, keeping more money in your pocket in the long term. To pay off debt even sooner, consider taking advantage of onetime windfalls—like tax refunds or work bonuses—and applying those to your debt as well.

Debt snowball method

This approach involves paying off the loan with the smallest balance first while making minimum payments on your other debts. After the loan with the lowest balance is paid off, allocate your payments to the next lowest balance. Continue this until all your balances are paid off.

The snowball strategy is geared toward helping you rack up "mental wins" as you pay off small debts and check them off your list. For some people, having fewer overall outstanding debts helps reduce stress and give them more confidence to tackle their remaining balances.

With both strategies, it's a good idea to find out what your minimum payments are, verify that your budget allows you to consistently pay that minimum, and set up automatic payments to help ensure you never miss a payment deadline. This can help you avoid paying higher interest rates and fees in the short run.

Debt consolidation

If you're carrying a significant amount of debt, you might consider debt consolidation. This involves combining multiple debts into a single loan, often with a lower interest rate. You take out a new loan to pay off your existing debts, leaving you with just one monthly payment to manage. This can simplify your finances and potentially save you money on interest charges.

Balance debt payment with investing

We believe that you should first prioritize paying off any high-interest debt like credit cards . That's because high-interest debt can grow quickly and cost you more money over time.

High-interest debt, like credit card balances, can make it harder to save and achieve your financial goals. By focusing on these debts first, you can reduce the total amount you pay and improve your financial wellness faster.

For debt with a comparatively low interest rate, it's a good idea to compare the interest rate against the rate of return you hope to achieve with your investments. If the interest rate is lower than your projected rate of return, consider putting more of your money toward investing. If it's higher, it might be better to allocate more money toward decreasing your debt.

Robo-advisors can help you with this decision by aggregating your accounts and providing you with a better picture of your portfolio. If you're interested in learning more, check out Vanguard's robo-advisor, known as Digital Advisor.

As you review your budget and choose a strategy, remember that with planning and patience, it's possible to pay off your debts over time. Make sure to keep the bigger picture in mind, focusing on how reducing your debts will increase your financial wellness and improve your overall quality of life.

For more guidance, see these tips to boost your financial health.

Need help managing debt

Working with a financial professional or advice service can help you navigate some of these questions and prioritize your next steps.

There are a range of advice options, from fully automated investment tools to professional advisors, as well as hybrid offers that combine the two. The best approach for you will depend on how much you intend to invest and the complexity of your financial management needs.

If you're not sure, we have 3 questions that can help you choose the right financial advice.

And when you're ready, Vanguard's advice services set you up with a personalized plan, along with tools to help you tackle debt and save for your goals with greater confidence.