Credit Card Debt - A Plan to Downsize It
When it comes to making money, or spending it, you should know how you're doing, whether you're financially safe and sound.
To put it bluntly:Are you where you're supposed to be? What you need to answer that question is a rock-solid gauge, a guidepost to measure your financial status.
As it happens, that gauge already exists.
It's called the debt to income ratio.
This number shows what percentage of your monthly income goes towards paying various debts.
The higher the percentage, the worse you're doing.
Ideally, experts say, your monthly debt should not excced 36% of your income.
But it's harder to stay at that 36% level than you might think.
Everywhere people keep spending more and more.
While the national savings rate has hovered around zero for years, consumer debt has soared by 24% since 2002, according to the Federal Reserve.
How did we get into this situation?An overriding reason is the economy.
Economic growth has slowed.
Employers are cutting benefits and wage growth has essentially been flat.
At the same time, it's as easy to get credit as it is to consume calories.
Last year, the typical household received 68 credit card offers, 46% more than 1998.
Today, US households can tap into an average of $26,317 in credit, or more than half of the typical family's income.
And tap we do.
The average US household has amassed around $9,900 in credit card balances.
People feel that they should be able to afford all these things because everyone else does, and it's almost humiliating not to be able to.
Having some debt is inevitable, even desirable.
Few people can afford to buy a house without taking out a mortgage, and almost no one qualifies for a mortgage, or most other loans, without having a credit history that shows how quickly and successfully they've handled previous debt.
Butwhat debt makes sense, and what should you be paying off as fast as you can?Here are some guidelines.
Your house.
The old rule is that you shouldn't spend more than 2 1/2 times your income on a house.
The reality is we're spending more and putting down less.
The problem snowballs when we start tapping equity.
What you should do:Try to keep your fixed housing expenses, monthly mortgage payment, insurance and property taxes, but not repairs and maintenance, at 28% or less of your gross monthly income.
Cards and car loans.
Many financial planners say you should have no credit card debt at all.
Do not take out car loans for longer than three years.
Longer than that and the car usually has little or no value after you've paid it off.
You should only lease if you can write it off as a business expense.
If you can't, don't despair.
If your consumer debt payments, including a car loan, are less than 10% of your gross pay, you're still in great shape.
Other ways to control debt Pay more than required.
If possible, try to at least double the payment.
Also, never pay late if you can help it.
When you pay late, your card company can and will increase your interest rate.
You could go from zero interest to 28%.
Pay off consumer debt - then invest.
People sometimes make the mistake of investing regularly in mutual funds instead of paying off their credit card debt first.
But they need to shift priorities.
The funds you invest in may generate 10%, but for most people that still less than their credit card interest.
Refinance.
With the Fed cutting rates, it may make sense to refinance your mortgage.
That way you can free up more cash to pay down your credit cards.
If you have a lot of equity in your house, consider consolidating your debt with a home equity loan.
But take care not to run up your cards again, a temptation you may have with all of that fresh credit you'll suddenly have available to you.
Start an emergency fund.
In an ideal world, you'd have about six months of living expenses,( whatever you need to keep yourself sheltered, clothed, and fed), in savings.
At a minimum, try building a stash of $500 to $2000.
That won't protect you from job loss, but it will keep you from using your credit card for emergency expenses like a flat tire.
Don't spend your tax refund.
If you get a refund this year, use some of it to start your emergency fund, then put the rest toward your debt.
To put it bluntly:Are you where you're supposed to be? What you need to answer that question is a rock-solid gauge, a guidepost to measure your financial status.
As it happens, that gauge already exists.
It's called the debt to income ratio.
This number shows what percentage of your monthly income goes towards paying various debts.
The higher the percentage, the worse you're doing.
Ideally, experts say, your monthly debt should not excced 36% of your income.
But it's harder to stay at that 36% level than you might think.
Everywhere people keep spending more and more.
While the national savings rate has hovered around zero for years, consumer debt has soared by 24% since 2002, according to the Federal Reserve.
How did we get into this situation?An overriding reason is the economy.
Economic growth has slowed.
Employers are cutting benefits and wage growth has essentially been flat.
At the same time, it's as easy to get credit as it is to consume calories.
Last year, the typical household received 68 credit card offers, 46% more than 1998.
Today, US households can tap into an average of $26,317 in credit, or more than half of the typical family's income.
And tap we do.
The average US household has amassed around $9,900 in credit card balances.
People feel that they should be able to afford all these things because everyone else does, and it's almost humiliating not to be able to.
Having some debt is inevitable, even desirable.
Few people can afford to buy a house without taking out a mortgage, and almost no one qualifies for a mortgage, or most other loans, without having a credit history that shows how quickly and successfully they've handled previous debt.
Butwhat debt makes sense, and what should you be paying off as fast as you can?Here are some guidelines.
Your house.
The old rule is that you shouldn't spend more than 2 1/2 times your income on a house.
The reality is we're spending more and putting down less.
The problem snowballs when we start tapping equity.
What you should do:Try to keep your fixed housing expenses, monthly mortgage payment, insurance and property taxes, but not repairs and maintenance, at 28% or less of your gross monthly income.
Cards and car loans.
Many financial planners say you should have no credit card debt at all.
Do not take out car loans for longer than three years.
Longer than that and the car usually has little or no value after you've paid it off.
You should only lease if you can write it off as a business expense.
If you can't, don't despair.
If your consumer debt payments, including a car loan, are less than 10% of your gross pay, you're still in great shape.
Other ways to control debt Pay more than required.
If possible, try to at least double the payment.
Also, never pay late if you can help it.
When you pay late, your card company can and will increase your interest rate.
You could go from zero interest to 28%.
Pay off consumer debt - then invest.
People sometimes make the mistake of investing regularly in mutual funds instead of paying off their credit card debt first.
But they need to shift priorities.
The funds you invest in may generate 10%, but for most people that still less than their credit card interest.
Refinance.
With the Fed cutting rates, it may make sense to refinance your mortgage.
That way you can free up more cash to pay down your credit cards.
If you have a lot of equity in your house, consider consolidating your debt with a home equity loan.
But take care not to run up your cards again, a temptation you may have with all of that fresh credit you'll suddenly have available to you.
Start an emergency fund.
In an ideal world, you'd have about six months of living expenses,( whatever you need to keep yourself sheltered, clothed, and fed), in savings.
At a minimum, try building a stash of $500 to $2000.
That won't protect you from job loss, but it will keep you from using your credit card for emergency expenses like a flat tire.
Don't spend your tax refund.
If you get a refund this year, use some of it to start your emergency fund, then put the rest toward your debt.
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