Credit cards

Smart: Using credit cards to establish a credit history. Credit cards are the fastest and most effective method for establishing a credit history. Use them for everyday purchases like gas and groceries, and pay them off every month to avoid finance charges.

Not so smart: Using credit cards because you don't have cash. If you are carrying a balance on your cards and are scrambling to make payments, you are misusing your credit cards. Cut them up until they are paid off. Then don't spend money you don't have.

Home Buying

Smart: Buying a home that fits your budget. Mortgage debt is considered "good" debt, since homeownership indicates fiscal responsibility and stability. In addition, mortgage interest payments are generally tax deductible.

Not so smart: Buying more home than you can afford. Just because a lender offers you a low monthly payment and approves a large loan amount doesn't mean you can afford the house. If the loan is structured so that payments are low initially, but may rise in the future, you could be in for a nasty shock, especially when interest rates are rising. Be sure you run all possible future scenarios before signing on the dotted line. If it seems too good to be true, it probably is.

Retail Store Credit

Smart: Same-as-cash financing. Especially for large purchases like furniture or appliances, same-as-cash financing can be a good deal. It's basically an installment plan that allows you to pay off the purchase in 60 or 90 days without paying interest. If you don't pay off the balance by then, interest usually kicks in and you end up paying more overall for your purchase.

Not so smart: Opening store credit cards and overspending. Many stores offer purchase discounts if you open a credit card with them. If you open a store credit card everytime you make a purchase, you could be paying much more in the long run. First off, opening multiple new lines of credit can hurt your credit score. Secondly, if you find yourself pulling out those new credit cards every time you shop, carrying high balances, and only making minimum payments, you are on the way to debt of the four-letter-word variety.

Step 1: Know your debt. Make a list of all non-housing-related debt: car loan, credit cards, retail store credit cards. Next to each write down the monthly payment, the total amount you owe and the interest rate you pay on the card or loan. Total up the debt and monthly payment columns.

Step 2: Create a budget. Next, you need to know what else you are spending your income on. Using your debt list as a start, add your other monthly expenditures: housing, utilities, groceries, gas, memberships, any monthly savings, discretionary spending. Track your spending for a month by writing down what you spend, or by using online banking.

Step 3: Create a pay-off plan. Consider tapping into your savings. (Though you should always keep an emergency fund that can cover three to six months of expenses.) If your savings is earning 5 percent, but your debt is costing you 10 percent in interest, you may be better off using your savings to pay down your debt. If you have equity in your home, you might also consider consolidating your debt with a home equity loan, line of credit, or a cash-out refinance, which will typically have a lower interest rate than credit cards. In addition, the interest you pay may be tax deductible.

Step 4: Curtail your spending. Even if you consolidate your debt with home equity or a consolidation loan, all the financial benefit is wiped out if you continue to rack up more debt. (And you could end up in danger of losing your home.) Cut up your credit cards. (But don't close them; this can have a negative effect on your credit.) Look for ways to save: take advantage of coupons, sales, and special offers. Pack your lunches rather than eating out.

Step 5: Be disciplined. Once you have a plan, stick to it. You need not deny yourself all pleasure - in fact, you shouldn't, because that makes it harder to stick to the plan. But be smart about your spending. Resist the urge to splurge, unless you've carefully planned. And remember the golden rule of finances: don't spend more than you make.

What is a debt consolidation loan?
A debt consolidation loan is a loan used to pay off other, potentially higher interest rate debts, like credit cards, auto loans or retail store credit. You pay off those debts with a debt consolidation loan and then make one monthly payment on the new loan.

How does it affect my credit?
Applying for a debt consolidation loan will most likely not impact your credit score significantly one way or the other. Since you are paying off several other debts with the new loan, credit rating agencies will note that your other accounts have been paid off. In fact, if you manage to make your debt consolidation loan payments consistently, your score may even improve over time.

Should I close my old accounts?
If you do use a debt consolidation loan to consolidate high-interest debt, it's a good idea to carefully consider how to deal with the accounts you pay off. You may be tempted to close your credit card accounts in order to remove temptation. However, closing accounts can actually have a negative impact on your credit score. This is because credit bureaus look at the amount of credit you're using compared with the total amount you have available. So closing zero balance accounts reduces your unused credit and may make it appear that you are overextended. In addition, credit bureaus look at the length of your credit history. (The longer you've been using credit responsibly, the better.) So if you do decide to close several accounts to remove temptation, consider closing the newest ones first.

Good debt vs. bad debt
A helpful rule of thumb is that good debt helps you achieve a goal or build assets, like home ownership or an education. Even some revolving credit, like credit cards, can be a good thing because a record of responsible debt management helps build your credit history.

By contrast, bad debt is debt you acquire for items you don't necessarily need - and that don't help you build wealth. Bad debt enables you to live beyond your means, like maxed out credit cards.

Replacing bad debt with better debt
Unfortunately, you can't just just call up the bank and say, "Please erase my debt." You have to pay what you owe, but often you can do it more cheaply by consolidating your debt into one loan with a lower interest rate and a single payment. Your debt may be of the "bad" variety, but consolidating it may lower your interest rate and simplify the process of paying it down. Once this debt is paid off, you can focus on the "good" kind.

A numbers game
When deciding whether or not to pay off a particular debt, you want to weigh the cost of the debt against what you'd earn if you put that pay-off money elsewhere. For instance, let's say you have a car loan with an interest rate of 2.5 percent and you have $5000 left on the loan. You could pay off the car loan now and save $125; or you could put that $5000 in a high-yield savings account at 5 percent and earn $250 over one year.

Other factors for living debt-free
If you are approaching retirement or anticipating any phase in your life where your income will be fixed or unpredictable, you may want to consider paying off your debts to ensure that you have enough cash for living expenses. Likewise, if the idea of any debt at all keeps you up at night, you might consider paying them off for peace of mind and a good night's sleep.