Downsizing Debt

Interactive Video

[A man sitting on the floor holding several credit cards in his hand, surrounded by receipts and bank statements.]

Narrator: Debt is a reality for most people. About 80 percent have some form of debt, including home mortgages, credit card balances, or student loans. 

[ An animated bomb rolls on screen and blows up the pile of money, leaving smoke clouds.]

[A smiling couple discussing money. The man is holding cash while the woman writes in a notebook.]

Living debt-free is the ultimate financial goal, but it’s not timely or realistic for everyone right now. 

[A bullseye with an arrow in its center labeled “debt-free.” A bill appears with the word “paid” stamped on it.]

[A person completing a loan application.]

Picture this: Maybe you’re in school and don’t have a regular income. Or life has thrown a curveball like a pandemic, a natural disaster, or a health issue, and suddenly you have no choice but to take on some debt. 

[Icons appear on screen]: education, pandemic, disaster, health

[On screen text]: debt-to-income ratio

[A balance scale with the word debt on one side and the word income on the other. The scale swings back and forth depending on which is greater.]

So how much debt is too much? You can use the debt-to-income ratio calculation to ballpark where your debt stands. It compares how much you're spending vs. how much income you’re bringing in. 

Try calculating Lisa’s debt-to-income ratio. Then you can figure it out for your own expenses later.

Add up all Lisa’s monthly bills and minimum credit card payments to figure out her total monthly expenses. Then, enter that number. 

Lisa’s Income:

Date: 1/5 Amount: $1,750 Source: paycheck

Date: 1/19 Amount: $1,770 Source: paycheck

Total Income: ?

Lisa’s Expenses

Date: 1/5 Amount: $1,180 Source: rent

Date: 1/7 Amount: $113 Source: utilities

Date: 1/9 Amount: $200 Source: groceries

Date: 1/10 Amount: $120 Source: credit cards

Date: 1/21 Amount: $275 Source: car payment

Date: 1/25 Amount: $297 Source: student loans

Total expenses: ?

[On screen text]: Add up Lisa’s bills and enter that number (text entry box provided).

Answer: Lisa’s expenses = $2,185

Next, figure out her monthly gross pay. Enter that number.

Answer: Lisa’s monthly gross pay = $3,520

Finally, divide her total monthly expenses by her total monthly gross pay to calculate the final number. That percentage is Lisa’s debt-to-income ratio.

[On screen text]: 

Divide Lisa’s expenses by her gross monthly pay to find her debt-to-income ratio.

$2,185 (total monthly bills) ÷ $3,520 ($3,520) = ?

[On screen text]: Lisa’s debt-to-income ratio is 62%.

A ratio under 36 percent is manageable debt. A ratio between 36 percent to 42 percent is borderline, and you should look at strategies to pay down debt. A ratio above 42 percent becomes troublesome. The best ratio, of course, is 0 percent! 

[A debt-to-income-ratio meter showing: the best score is less than 36% - manageable, the medium is 36% - 42% - borderline, and the worst is greater than 42% - troublesome]

[A woman with a frustrated look on her face, holding a credit card in her hand with a laptop on her lap. There are two shopping bags behind her on the floor.]

If your goal is to downsize debt, you have to put your spending on a diet. 

[On screen text]: downsize debt

[A person with a tape measure around their waist, holding a salad in one hand and dumb bells in the other.]

Have you ever heard that to lose weight, you have to take in fewer calories than you put out?

[Measuring tape wrapped around a stack of bills.]

[On screen text]: spend less

Well, the same is true if you want to shrink your debt. You need to spend less to have more money available to pay off those balances.

Consider some ideas to shrink your debt faster. 

[Animated calendar showing that a payment is due January 1st.]

If it’s a smaller debt, think about paying more than the minimum monthly payment. Pay as much as your budget will allow. You can make a dent in debt with simple changes to your spending habits. 

[Animation]: Text appears “Pay as much as you can.” Then a hand pushes a large stack of money toward the debt next to a smaller stack of money.

[Animated person struggling to hold up a ball labeled “debt.”]

It’s more difficult to notice progress in larger debt amounts, because the balance continues to accrue interest. Larger amounts of debt may require a different solution. 

IOn screen text]: accrue interest

[The animated person is now lying on the ground with the debt ball on top of them.]

[On screen text]: Pay off balances from smallest to largest.

[Animation demonstrating paying off bills in order of smallest to largest. First, the medical bill disappears $450, next the credit card bill disappears, “$2,387,” then the car loan bill disappears $11,117. Finally, the condo bill disappears $80,452.]

One strategy is to pay off balances in order from smallest to largest, regardless of their interest rates. Pay the minimum amount on all debts except the smallest balance. Put that extra money toward the smallest debt until it’s paid off. Once the smallest debt is paid off, use the money you put toward that small debt to pay more on the next smallest debt, until that’s paid off. Continue this process with all your debts until you’re at zero debt. [As each bill disappears, a larger amount of coins is added to the next largest debt.]

[A couple smiling and celebrating. The man is holding papers in his hand.]

Paying debt this way motivates you to keep going. Successfully knocking out your smaller debts will drive you to tackle your larger debts. [A hospital bill appears at $1,143 followed by a bill for student loans at $27,984.]

[On screen text]: Pay the highest interest rate first.

[Animation demonstrating paying off debt in order of interest rate from high to low. Debt 1, credit card, at 18% disappears first. Debt 2, car loan, at 12% disappears next. Debt 3, condo, at 4% disappears. Finally, debt 4, medical bill at 0% interest disappears.]

An opposite method is to pay your debt with the highest interest rate first. Then you work backward to the debt with the lowest interest rate.

[On screen text]: Use extra income to pay down debt.

[A smiling woman wearing a chef’s uniform.]

On the other side of the equation, you can increase your income with some side work. You can use that extra income to pay down your debt faster. [The same woman is now dressed in a customer service uniform.

[On screen text]: debt consolidation

Or you might try debt consolidation to help manage your debt payments. When you combine debt from multiple sources into a single payment, it becomes easier to track and you’ll have a more manageable monthly payment and, possibly, even a lower interest rate. [An animation that shows debt being consolidated with several bills: medical, credit card, car loan, mortgage, moving together in a circle. Money increases as the debts are consolidated.]

[A man looking bewildered while sitting in front of his computer holding a piece of paper.]

[On screen text]: credit counseling

If your debt is overwhelming you, consider credit counseling. A professional credit counselor can work with you to develop a debt-management plan. While this will cost you money, professional guidance can identify solutions you might not find on your own. 

[On screen text]: debt solutions

[An animated evil-looking character in front of a laptop with a skeleton icon on it.]

But be on the lookout! There are several credit counseling options that are frauds or scams. 

[Personal documents such as driver licenses, cash money, and bank cards with hooks in them being stolen by scammers.] 

Visit ftc.gov for guidance on choosing a good credit counseling option.

[On screen text]: ftc.gov