Take Control of Your Finances
There’s a lid on the amount of debt you can comfortably take on, generally tied to your income. Too much, and you’ll quickly find yourself in a bind. Here’s how to land on your sweet spot.
Average Debt in the US
Some food for thought: As of December 2019, the average amount of student loan debt among people who have it was $46,679; the average amount of credit card debt, $7,104. And as for home mortgage loans? $192,618 per household, according to Nerdwallet. Depending on how your finances compare — average, above average, or below average — you may be wondering, “Is this too much debt?”
It’s a very good question. Generally speaking of course, less debt is better. The money you’re now putting toward your credit cards or other high interest rate debts could be used for retirement savings, an emergency fund or your child’s education. Still, there are things (necessities) that very few of us could buy without taking on debt like cars, homes and education.
The borrowing you do to finance these endeavors is good debt. It gets you something important – that roof over your head, the wheels you drive back and forth to work and the education that helps you earn more throughout your life. You can usually discern it from bad debt (the kind that gets you things you don’t actually need) because the interest rate will be lower and sometimes tax deductible.
So, how do you know when you’ve overdone it? The key is to consider your debt-to-income ratio — that is, the percentage of your income that is going to your debts. As a general rule, your total debts (excluding mortgage) should be no more than 10 percent to 15 percent of your take-home pay. If you’re not likely to incur any additional debt or unexpected expenses, you may be able to handle upward of 20 percent. Including your mortgage, your debt level should exceed no more than 36 percent of your take-home pay.
Why 36 percent? Your debt-to-income ratio (DTI) is a number as important as your credit score. Lenders look at the ratio when trying to decide if they should lend you money or extend credit. A DTI of 36 or lower shows that you have a good balance between your debt and income and that you can handle your monthly loan payments.
You can calculate your DTI with a pen and paper or calculator. First, add up all of your monthly debt obligations: your mortgage, home equity loan payments, car loans, student loans, the minimum monthly payments on your credit cards, and any other loans you may have. Divide this sum by your gross monthly income, and voila — you’ll have your DTI.
If your debt load is higher than 36 percent of your monthly gross income, now is the time to consider paying down the debt if you’re not already doing so. Cut back on your spending or look for ways to reduce your expenses. With mortgage rates lower than usual (the 30-year fixed-rate mortgage was 3.93% at the end of 2019 and is expected to stay low in 2020), the first thing you should do is consider refinancing. And don’t stop with your house — you may be able to refinance your auto loan at a lower rate, too.
Make a Plan
Even if your debt load is low, remember: there may be better ways to use that money. No matter how much debt you’re carrying right now, make sure you have a plan to pay it down — and then once it’s gone, take those payments and start directing them towards your future goals.
Article courtesy of SavvyMoney
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