October
26 - 2015

Differentiate between Good and Bad Debt

Most people have debt of some sort. It does not necessarily mean a problem. The real estate market would be virtually non-existent without mortgages that tend to be long term, up to 30 years, at a rate which reflects the current economic climate. If rates are low it certainly makes sense to look at a fixed rate mortgage as the easiest way to budget. If the rate is flexible then things can obviously change, up and down. The fact that real estate is a good medium to long term investment means that the mortgage is good debt; you will be able to build up an asset as a result.

Student debt is probably positive debt as well. Interest rates are not onerous and repayment can be deferred until you are working and able to do so. If you graduate your prospects will improve and funding your education will have been worthwhile.

Stressful

In contrast there is debt that results in serious stress. If your debt gets out of control you will probably live with stress on a daily basis. It is so tempting to take out that piece of plastic from your wallet to buy something even if you are short of money. You may even do it to withdraw money when your bank balance is low and the pay check some days away. The problem is that if you cannot pay off your balances at the end of the month a high rate of interest is then added. As the months go by if you can only afford to pay the minimum the credit card company requires the balance will hardly drop and of course if you continue to spend on the card your problems will worsen.

You should set yourself a challenge and that is to prepare a budget and stick with it. Before you can happily follow a budget you may well have to take some action to ensure that expensive debt is addressed and the budget is showing a monthly surplus.

The Ratio

As a guide you should aim to achieve a debt to income ratio of 40% maximum. That means if you earn $5000 a month before tax and any other deductions, you should limit your debts, including mortgage, to 40% of that; in other words $2000. There is the positive debt described above, the mortgage but you need to think whether some of the other debt can be reduced.  Credit card debt is the most common problem. It is cheaper to pay that off with a personal consolidation loan with no credit check that will be at a lower interest rate. The instalment figure can then replace the credit card company figures in the budget.

Credit Score

Your credit score is important. It is created from your credit history but everyone is also judged by their debt compared to their total credit facility. If for example you pay off your balances on your cards. You should not then close the account because you have an unused no credit check credit limit which is positive in assessing your credit score.

Some financial institutions will not consider an application from anyone with a poor credit score and certainly a good score is essential for those looking to get a mortgage. Within the financial sector there are online lenders who look instead at whether an application is realistic and whether the applicant can afford the repayments. That depends upon regular income. History is not as important though these lenders will probably charge a slightly higher interest rate for those that have had problems in the past.

Money is available then and it is important that when you are looking for it you have a clear idea of why you are seeking it and what implications it has on your budget and future finances. You may be running positive debt such as a mortgage throughout your life but you must also be saving at the same time. Ask yourself what you would do if you suddenly faced a financial emergency? Have you got a fund that you can access to pay the bill? Equally when the day comes when you retire, are you relying solely on the Social Security System to fund a comfortable retirement? That is unrealistic and you should be saving towards retirement at the earliest possible opportunity.

 

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