No one likes to be in debt, but the truth is, almost everyone is. Your goal -- the goal for everyone -- should be to have as little debt as possible so that you can keep as much of your hard-earned paycheck as possible. The trick is how to get there. You need to have realistic expectations and, with a little discipline, you can have peace of mind that you are in good financial shape.
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If you went to a bank and asked for a loan, one of the first things they would want to know is what is your debt-to-income ratio. Banks believe that the amount of your monthly debt payments should be no higher than 36 percent of your gross monthly income. Ideally, it should be around 10 percent, but if it’s less than 20 percent, you’re still considered to be in pretty good shape. This means that the money you pay out every month for your mortgage, including taxes and insurance, credit card payments, car and other loans should not be more than the 36 percent figure. Before you panic, remember that the calculation is on your gross income, not your take-home pay. What's left over has to pay for everything else: living expenses, utilities, clothes, food, entertainment and those lattes you get every morning on the way to work. Sure, you put some of those things on a credit card, but that increases your debt, which increases your monthly payment -- and besides, the whole point is to get out of debt, right?
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Your monthly mortgage, plus taxes and insurance, should not be any more than 28 percent of your gross monthly income. So, if you make $4,000 per month, your monthly mortgage debt should not be any more than $1,440.
Credit Card Debt
Credit cards, unless you pay them off every month, are a cancer on your finances. Bite the bullet. Pay them off as soon as you possibly can; then only charge what you can pay for in full when the statement comes. Here’s why: interest on credit cards is ridiculously high and all that money you are paying in interest can be put to much better use. What’s more, 30 percent of your credit score is based on your “credit utilization rate,” or how much you have used up of the credit that has been extended to you. Add up all the amounts of your credit limits on your cards then divide it by the sum of all your outstanding balances; that’s your credit utilization rate. So, if the sum of credit limits is $10,000 and you owe $5,000, then your credit utilization rate is 50 percent. As a rule of thumb, anything more than 30 percent could negatively affect your credit score.
You Owe It to Yourself
Give yourself some credit and be a creditor to yourself. Pay yourself a monthly payment for savings and investment. Treat it as you would any other debt you have to pay every month. This is the one monthly debt payment that should be as high as possible.
Lisa Dorward was a corporate financial executive and business consultant for more than 15 years before becoming a writer in 2003. She has B.A. degrees in both history and creative writing and earned her M.F.A. in creative writing in 2008, specializing in novel-length historical fiction.