How to avoid the pitfalls of creeping debt.
By Debs, DebtSteps.com
Reducing debt usually isn't a high priority for people until
they have already gotten into trouble with overspending.
Using a few basic guidelines, and debt calculations, can
help you see when your debt load is getting into the danger
zone.
Budgeting Guidelines
First off, creditors use budgeting guidelines when
reviewing and approving credit. If your debt exceeds the
financial communities recommended guidelines, then you have
a higher risk of credit applications being denied.
Getting, and keeping, your debt in line with
recommended budgeting guidelines, is an important step in
debt reduction. Use the following recommended budgeting
guidelines (the same ones used by Financial Institutions) to
review the items in your budget:
- Housing 35% - Mortgage
or rent, taxes, repairs, improvements, insurance,
and utilities;
- Transportation 20% -
Monthly payments, gas, oil, repairs, insurance,
parking & public transportation;
- Debt 15% - Credit cards, personal
loans, student loans & other debt payments;
- All other expenses 20% -
Food, insurance, prescriptions, doctor & dentist
bills, clothing & personal;
- Investments & Savings 10% - Stocks,
bonds, cash reserves, retirement, rental real
estate, art, etc.
Debt Income Ratios
The second step is calculating your debt income ratio. Once
you know what your ratio is, you will understand just how
important debt load is to your overall financial picture.
Your debt income ratio is the percent of your monthly
take-home pay that goes to paying debts.
You calculate it by taking the amount needed to repay debts
each month, including rent or mortgage, and divide by your
take-home pay (your net pay after taxes). Remember, this is
"Debt" ratio, so only include actual debt repayment in the
calculation.
Credit To Debt Ratio
Just because you pay off a credit card is no reason to
close your account. One little known fact about the Credit
to Debt Ratio is the reverse effect it has on your credit
score. If you pay off a credit card, and close the account,
you are actually negatively impacting your credit score.
The reason for this negative effect is in the calculation
of the Credit to Debt Ratio itself. This ratio is the
relationship of your debt total vs. your credit limit.
You calculate it by dividing the total credit limit of all
credit cards and loan accounts by the total of the actual
debt (spent total). Now, if you pay off a credit card, you
are reducing the actual debt, which is great, but, if you
close the account, you are also dramatically reducing the
credit limit you have, and usually by a higher percentage
than the debt reduction.
Pay Yourself First
Essential to long-term financial success, and protecting
your future, is paying yourself first. While this may seem
easy to do, it happens to be the last thing most people do,
instead of first. Debts and other financial obligations,
money for entertainment, and other spending always seem to
take a higher priority. All I can say is, STOP! Think about
it, if you aren't worth being paid first, then who is?
Always put something away in your savings, and leave it
alone. It doesn't matter if it's only $5 a week, just do it!
Snowball The Credit Cards
Last, but not least, is making extra payments, not just the
minimum payments, on your credit cards. You have probably
already seen this many times, but it just can't be stressed
enough. Paying just $10 extra a month on a credit card,
above the minimum required payment, can cut your repayment
term in half, if not more! So, squeeze out that extra
payment, however small, every month, and take advantage of
the compounding effect of snowballing your debt away.
The Power of Financial Knowledge
Remember, you don't have to be a financial whiz to
understand what's going on with your credit and debt. Just
a few simple calculations, and an eye on the future, will go
a long way to help you succeed financially and keep your
debt under control. Be safe, be smart, do the math!
About the AuthorArticle courtesy of: href="http://www.debtsteps.com/">DebtSteps.com offers
comprehensive reviews of your options for debt relief.
From budgeting to bankruptcy, debt consolidation, and credit
counseling. href="http://www.debtsteps.com/">DebtSteps.com is where
you can get the answers to your questions absolutely free.
Copyright 2004 DebtSteps.com, all rights reserved. Reprinted
with permission.
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