Here’s a guest post from Alban.  He is a personal finance writer at Home Loan Finder, a home loan comparison website.  Thanks Alban for such a detailed post on the “D” word!

Debt is something we all deal with in our everyday lives because we are all in some form of debt. Whether you have a car loan, a credit card or a mortgage, or whether you drive the car you bought with a car loan back to your mortgaged home, paying for fuel with your credit card on the way – we can all do with finding out how to better manage our debts.

1 – Know the types of debt

Debt is often referred to as either good or bad, where good debt is a home loan or investment loan which is held by an appreciating asset, where bad debt is high interest debt such as credit cards or personal loans which have been used to buy depreciating assets. However, these tags can be dangerous if you plunge into a large home loan or abandon the use of credit cards without understanding why.

Instead – keep in mind that bad debt is any type of debt you can’t afford. Your home loan could be bad debt if you borrow more than you can comfortably afford to repay, and your credit card could be good debt if you pay it off before the end of the interest free period and use the bank’s money while your money earns interest.

Therefore, the first thing you need to do when managing your debt is find out about the three true different types of debt:
1. Secured or unsecured. A debt is secured or unsecured based on whether there is collateral against which the loan has been secured. A secured debt is one which involves collateral and the collateral for a loan is usually also the reason for the loan – for example a car loan is secured against the car you purchase, and a mortgage is secured against your home. If you become unable to repay your secured debt and default on the loan, the lender is able to take the collateral of the loan, to cover the outstanding amount. Unsecured debt is one where you didn’t have to put up collateral, such as your credit card and as the amount you owe is unsecured, you often pay a higher interest rate.
2. Instalment or revolving debt. If you make the same repayment amount to your loan each month then you have an instalment debt, because the repayments have been calculated to repay a portion of both the principle and the interest accumulated, so that at the end of the loan term the debt is repaid in full. Revolving debt such as a credit card can have fluctuating repayments depending on the balance of the card and new purchases you have made. With an instalment debt there is no risk that your repayments or your loan amount will change because you have borrowed a specific amount for a specific purchase. With instalment debt you have security and reliability in your repayments and your budget.
3. The source. The issuer of the debt will determine the final features of the debt, most importantly the interest rate, because if you have a Visa card from ANZ Bank and a Visa card from Westpac Bank, the interest rates and fees will be different. This is why you always need to be aware of how your provider is categorising your debt as far as its features and usability.

2 – Know your debt

The next important step to managing your debt is knowing your current debt levels and circumstances. To do this, make up a list or a spreadsheet which includes:
The balances of all of your debts.
The interest rate you are being charged for each.
The term remaining on your contract if it is instalment debt.

Then look at the totals of your debts in relation to your overall budget and your income. Knowing your debt to income ratio is important to successfully managing your debt and maintaining your lifestyle, because while it is almost impossible for most of us to be debt free, you need to strike a healthy balance.

There are two types of debt to income ratios what you should work out as you are getting to know your debt:
1. Front end ratio. Your front end debt to income ratio is the ratio of your income which is going to cover debt for your housing costs such as your mortgage. This includes the costs of your mortgage repayments, interest charges, mortgage insurance, home and contents insurance and property taxes.
2. Back end ratio. The back end debt to income ratio is the percentage of your income which goes towards paying recurring, which include the costs of your home, plus your car loan, credit cards or student loans.

To give you an idea of a healthy debt to income ratio, most lenders use a ratio of 28/36 to decide if you qualify for a loan. For example, if your annual gross income was $45,000 your monthly income would be around $3,750. To calculate a healthy amount of your income to spend on debt:

$3,750 x 0.28 = $1,050

So $1,050 of your income should be allowed for housing expense, or front end debt.

$3,750 x 0.36 = $1,350

And to cover the back end debts of your housing expenses and your recurring debts, you should allow no more than $1,350 from your monthly income. This leaves you with a healthy $2,400 each month for your living expenses and savings.

3 – Get rid of debt which is bad for you

Now that you understand your debt it is time to take charge and get rid of the debt which is bad for you. this could mean downsizing a home loan you can’t afford, or cutting up your credit cards once and for all. However, before you cut up your credit card for good, you will need to repay them in full, and you can make a few simple lifestyle changes to get rid of this most common form of debt:
Change your attitude. In managing your debt you need to create a shift in your mind towards spending less than you earn. It is easy to get into the habit of putting purchases on your credit card when the money in the bank has run out, but this is not managing your debt – it is not even managing your finances. Instead, resolve to live within your means and start saving instead of spending and you’ll be back in control.
Stop spending. Now it’s time to put that resolve to the test, because the easiest way to repay your credit card debts is if the balance stops increasing. Therefore, chop up the cards, put them in the freezer or hide them in s drawer, just hold onto the payment details so you make pay down the balance.
Consolidate debts. Debt consolidation loans can be helpful for managing multiple credit cards and personal loans as they are all rolled into one loan amount, with a lower interest rate, set repayments and a set term.
Balance transfer credit card. If you want to continue to manage your credit card debts yourself as you become debt free then look for a balance transfer offer which will pay out your existing credit cards with low or 0% interest cards. Your balances will be transferred to these low interest cards, and the low interest rate applied for a certain period to give you a chance to repay more from your principle balance.

4 – Stay free from bad debt

Keeping your finances in balance and making sure that all of your debt is good for you is an ongoing process and there are three main ways you can keep on track and you manage your debt into the future:
1. Maintain your attitude. It is not enough to believe you are doing the right thing as you are getting your debts under control, only to splurge again down the track. Therefore, make sure you maintain sight of why you are controlling your spending and don’t be too hard on yourself – you don’t have to go without new clothes all together, just lay by them instead of buying them outright.
2. Budget. Once you get into the habit of keeping a budget and sticking to it you will be amazed at how easy your life becomes. You will have collated all of your incoming funds and outgoing expenses, and will enter all of your purchases regularly so at any one time you know how much money you have left and whether you can afford to go out for lunch, or whether you should take left overs to work.
3. Build an emergency fund. Many people justify credit cards as great in an emergency – which they can be. However, they also have the potential to create their own emergency down the track when the statement comes and must be paid. Instead, as part of your budget, make sure a portion of your income is going towards building an emergency fund which should be enough to cover around three to six months worth of wages. Also remember, if you dip into your fund because of an emergency, top it up as quickly as you can.

5 – Use debt for good

Managing debt effectively doesn’t just mean getting rid of credit card debt or refinancing to a more affordable home loan. It can also mean using debt to increase your net worth, and decrease your tax obligations. For example, a margin loan used for shares or investment funds offers you the following benefits, if managed correctly:
Higher investments mean higher returns. If you make investments with borrowed money, you are able to invest larger amounts than you would just using the money you can scrape together from your savings. Plus, with your savings and emergency fund intact, your opportunities for a high investment return increase thanks to a higher investment amount.
Flexibility. With a margin loan you can also have instant access to additional funds if you want to take advantage of an opportunity in the market, without selling your current stocks. A margin loan and stock investments are also more liquid and less volatile than investment properties, which can be hard to liquidate quickly, and if you need cash from your investments, you can lose out from a quick sale of property.
A diversified investment. Since you have a greater investment portfolio, you are able to spread your investments across a wider range of shares, and therefore reduce the risks associated with your investment.
Tax benefits. The interest you are charged on your margin loan is tax deductible meaning you can reduce the amount you have to pay at tax time. There are also tax benefits if the dividends you are paid from your shares are franked, as the tax has already been paid by the company.

Youngandthrifty’s note: Readers, any ways of debt management that Alban has mentioned you currently employ?  Do you have other ways to manage debt effectively that you can think of?