Don't Debt The Small Stuff
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Debt. It’s only a four-letter word but it’s a big one for most of us. Being in debt can affect our health, our relationships, and our ability to create financial security. In their 2018 Financial Capability Study, the FINRA Investor Foundation found that 8 of 10 Americans surveyed were in debt with 37% of total respondents feeling they had ‘too much’ debt.
‘Yeah, and the sky is blue’ you might be thinking right now.
You have debt and your sister and your mom do too. Besides, you rationalize, isn’t it the American way to buy on credit? Keep the economy going and all that stuff.
Well, maybe it’s better to be on top of it. The key is to know your amount, track your spending, and start slashing. You’ll soon find yourself in a better financial situation.
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So you owe some money, but what happens though when the problem is bigger than just repaying the money you borrowed? When some of our financial resources are tied up repaying what we owe, we are hijacking more than just our money, we also are choosing to forfeit something equally precious – time.
Unless we have enough resources to repay our debt and save for our financial goals simultaneously, we are essentially trading the time that could be used for saving for debt repayment instead. For example, trying to reach a specific savings goal by age 40 is easier if you start at age 20 than age 30. The more time you have, the smaller the monthly amounts you need to save. If you have to shorten the amount of time you have to save because you had to repay debt, then you will either have to account for the lost time with larger monthly payments if you want to reach your savings goal at the same point in time or you will have to extend the date when your goal will be met.
Sometimes debt may be necessary. If you don’t have $15,000 or more saved up to buy a car, for example, you may decide to take out an auto loan. Or if you have an emergency need but don’t have emergency savings, you swipe your credit card instead. Even with the best planning, life happens and not always in a linear fashion. If you are going to take on debt, the key is not to get in over your head and get into too much debt.
You should never borrow more than what you are sure you can afford to repay (medical debt being one notable exception).
This is important for several reasons. First, you don’t want to fall behind because not only is doing so stressful, but it will also hurt your credit profile. On-time debt payments are 35% of your total credit score so having a late or missing payment can hurt your score significantly. Almost equally important to the health of your credit score is how much debt you carry. With credit cards, it is important that you don’t use more than 30% of your total credit limit available on your card in order to not negatively affect your score.
Secondly, even if you feel you don’t have too much debt because you can afford it, if the total of your minimum debt payments exceeds 43% of your gross (pre-tax) income, you may be at risk for being denied more significant loans like a mortgage. Mortgage lenders, in particular, can be wary of the stability of people who have high debt to income ratios.
You may be interested to know that even though you should be cautious about debt in general, not all debt is viewed in the same way by credit scoring organizations and lenders. Some debt is viewed as an investment, whereas other debt, for expendable short-term purchases that will lose value, is viewed as a true liability. Mortgage debt that has the potential to increase in value, and student loans that pay for an education that may increase the borrower’s future earning power, fall into the investment category. However, new cars and consumables like clothes, furniture, vacations, and credit card debt in general are considered liabilities.
Still, it’s important to remember that even ‘good debt’ can be bad for you if you can’t repay it. If the credit bureaus report a late or missing payment on money owed, the fact that the debt is good or bad will make no difference whatsoever when it comes to your credit rating.
What can you do to avoid being in debt or at least keep your existing debt from getting out of control? Make delayed gratification a part of your life. Notice I said ‘a part.’ Don’t make a beeline to remove yourself from the material world just yet. What delayed gratification means in the financial sense is not that you give up everything and live like a monk, but rather that you consciously choose to delay making a purchase until you know you can pay for it. This behavior can be very difficult to master, especially when family, friends, and social media tell us we ‘deserve’ to have something immediately. I assure you it will be more difficult to sleep if you are up at night because of overwhelming debt.
Also, if you haven’t done it already, it is important to build an emergency savings fund.
Decide what amount you need for your emergency fund and then set aside some money each week and commit to building it until it’s fully funded at the amount you have predetermined. Having a cushion of money set aside for emergencies can be the buffer that keeps you from going into debt or further debt.
Determine how much time and money it will take you to reach a specific financial goal. The US Securities and Exchange Commission has a free and easy to use compound interest calculator that can help.
Track your discretionary spending (this is what you spend on ‘wants’ not ‘needs’). If you use your credit card often for purchases, this is a good way to make sure you don’t use more than 30% of your available credit which could have a negative impact to your credit score. Check out the free downloadable spending tracking worksheets available here.
Start putting money aside in an emergency savings fund. There are several types of weekly and bi-weekly money charts that break down the process into manageable bites making it easier to stay on track with savings for the long term.
Accredited Financial Counselor
In 2008, Ms. Torres-Gale was chosen by the Financial Industry Regulatory Authority (FINRA) Foundation to be part of a select group of military spouses. Through this, she received FINRA sponsored training from the Association of Financial Counseling, Planning and Education and became an Accredited Financial Counselor® in February 2012.
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