Debt

Should We Really Worry about Debt or Is It Just a Bunch of Numbers?

A startling statistic made its rounds in November 2017: US household debt has steadily increased to $13 trillion. It appears that everything is on the up and up in the US economy, including household debt. Statistics indicate that mortgage-related debt is the biggest component of US household debt, at $8.7 trillion. Close in tow are student loan debts, automobile debts, and credit card debt – in that order. The $13 trillion figure is approximately $280 billion higher than the debt level during the global financial crisis in 2008.

I often wonder what all these figures mean if inflation is increasing at a modest pace, and wages and salaries are also increasing. Isn’t it to be expected that debt levels should increase accordingly? Of course, debt levels should increase at a healthy rate, but they should remain within a narrow range on the spectrum. Let me elaborate. If the Debt/GDP ratio was 30% and manageable, perhaps it would be good to aim to maintain that 30% ratio today. Is this doable? Probably not.

Understanding the 43% ratio

A more valuable measure of overall debt for individuals and families is the debt/income ratio. Experts routinely throw a figure of 43% around when they talk about the debt/income ratio. Why 43% you may ask? Well, statistical analysis has found that debt higher than 43% of your available income eventually becomes untenable.

So, if your total monthly payments (student loans, credit card repayments, mortgages, vehicle loans etc.) amount to $3,000 and your gross monthly income is $8,000, your debt/income ratio is 3/8 which amounts to 37.5%. It’s a lot, but it’s doable. If you’re looking to get qualified for a mortgage, don’t count on getting approved if that 37.5% becomes 43% or more. Experts will always consider your debt to income ratio when offering you a loan.

Managing Credit Card Debt Made Simple

A more pressing issue for me and my family is credit card debt and how to deal with it. I’ve noticed a surprisingly strong trend towards increased expenditure on credit cards. We all see these financial resources as our cash, but in fact it’s money that belongs to other people and it comes at a premium. The high APRs on credit cards should act as a disincentive to use them with impunity.

Any APR of 15% or more is a problem, especially if you’re allowing your daily balances to remain high. Most credit cards don’t come with such attractive APRs – they may offer you 22% – 28% on average. My financial advisors over the years have always told me that the best way to deal with debt is to actually deal with it. Don’t ignore it – it’s not going away. For example, one of the best options that you can employ is paying down high interest credit card debt first and then working your way towards the lower-interest debt. How would this work in practice?

  • Look at all your credit cards and pick the one with the highest APR and the biggest balance. This is a money eater. Now, work on repaying the outstanding debt as quickly as possible. You have several options available in the form of increased payments, more payments per month, or simply paying it off in one fell swoop with a debt consolidation loan. You certainly don’t want to get into debt again – so pay down your existing debts and apply sensible financial practices to your budget. The benefit of a debt consolidation loan is clear: You take out a loan at a lower rate of interest than your existing debt, you pay down the high interest debts, and you repay the loan. There are pay down options like using your tax return, or an H&R Block loan on that return, to pay existing debts.

Debt is pervasive, and a necessary evil. However, it needn’t be a bugbear that keeps you up at night. Manage your debt effectively by thinking twice before swiping your card. Do you really need that added expense? If you can afford to repay the debt within a month, consider making the purchase. If you don’t know how you will repay the debt – delay the big-ticket purchase.

 

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