It’s so easy to fall deeply into the abyss of debt.
Your friends around you are lining up to buy that new $769-minimum iPhone 7 that comes without a headphone jack. You figure you need to upgrade, too, plus buy the $150 Bluetooth headphones that go with it. The monthly payments won’t be too much.
Or your daughter will want the hot $60 Paw Patrol Zoomer Marshall pup for Christmas. But she outgrew her $139 winter coat from last year. You figure Santa can put a smile on her face Christmas morning while keeping her warm all winter if you just stretch a little and charge both items. The monthly payments won’t be too much.
Except that life’s expenses won’t stop after the holidays. You’ll still pay your rent or mortgage plus heat, groceries, insurance premiums, gasoline, cable and other bills. And what about the next new thing? Or the unexpected dental bill or, God forbid, a hospital stay?
You’re about to fall into the debt spiral.
But to help you sidestep a debt spiral in the first place, we’ve got these seven tips for you.
1. Know where you stand
First, a math test. Compute your household’s debt-to-income ratio, which figures what share of your income goes each month to pay debts. You want a low score.
Use monthly figures. Say your gross monthly income is $6,000, and you pay $1,500 a month for your mortgage, $200 a month for an auto loan and $300 a month for your credit cards. Your monthly debt payments are $2,000 ($1,500 + $200 + $300 = $2,000). Divide 2,000 by 6,000. Your debt-to-income ratio is 33 percent ($2,000 is one-third of $6,000). That’s already high.
The higher your debt-to-income ratio, the more likely you are to run into trouble making monthly payments, the Consumer Financial Protection Bureau warns.
Where do you stand? Utah-based Merrick Bank and others offer easy-to-use, online debt-to-income ratio calculators so you can compute your score. Merrick’s guide:
- Good: 0-20 percent.
- Moderate: 21-30 percent.
- Getting high: 31-40 percent.
- High: 40 percent-plus
If your ratio goes above 39 percent, you jeopardize your ability to buy a home or car or borrow for emergencies, Merrick says. And any money you do borrow will be at higher rates.
Also, the CFPB says, 43 percent is the maximum ratio for lenders to issue most “qualified mortgages,” which generally have more stable terms than other types of home loans.
2. Don’t try to keep up with the Joneses
Find a way to live not within your means but below them, says Stacey Black, financial educator at BECU, Washington state’s largest credit union.
“This means that you are saving on a monthly basis toward your goals,” Black said.
If the family next door gets a shiny new car every two years, you just saw a $4,000-plus, 65-inch OLED TV delivered there and the mom and daughter go out for mani-pedis weekly, they may be fine — but they may be living beyond their means. According to Bankrate.com, 1 in 4 families has more in credit card debt than they do in emergency savings. You don’t have to copy them.
Evaluate what you really need, analysts say.
3. ‘Charge it’ less
That $899 gold iPad Pro might not bust your charge card limit, but that’s not the test to see if you can afford it.
When you pay with credit, you’re really borrowing money that has to be paid back.
“When it comes to buying something on credit, if you can’t afford to save on a monthly basis, you can’t afford to buy it on credit, Black said.
If you charge $899 on a card with 15 percent APR, and make minimum monthly payments of $20, it will take you about 67 months to pay off your iPad, according to online calculators. In that time, you will pay $430 in interest charges — and by then newer, cooler models will be all the rage.
As a general rule, keep monthly credit card payments under 15 percent of your gross monthly income, advisers say — and under 10 percent would be even better.