Reasonable debt is something that you have to define for yourself. If you ask a real estate broker or jewelry salesperson what is reasonable debt for you, the answer will probably be different than if you ask a financial counselor. You must decide for yourself what is reasonable for your own circumstances using sound financial guidelines and planning, preferably by keeping a budget.
20 Percent Rule
Some advocate using the 20 percent rule when considering how much debt is reasonable. This means that the amount of your monthly payments for debt, not including your house, should never exceed 20 percent of your take-home pay. If you take home $4,000 per month, you should have no more than $800 in monthly payments. Using the 20 percent rule forces you to budget and review your finances regularly, but it still may be too much debt depending on your circumstances. Also, it considers payments only, and not the total level of debt, which is more important to your long-term financial health. Everyone tends to spend more money when only considering monthly payments.
Mortgage Debt
A mortgage banker will probably say that you can handle a mortgage payment of 28 percent of your monthly income. A real estate broker may say that you can purchase a home that has a purchase price of 2 1/2 times your yearly income. Who is right? It depends on your situation and what works best for you. The 28-percent-of-income payment and the 30-year mortgage are considered the norm in home financing. However, a 15-year mortgage will get you out of debt on your house in half that time, with somewhat higher payments. Overall, mortgage debt is one of the most reasonable forms of debt if the payments and debt level are kept within your budget.
Consumer Debt and Credit Cards
Many consumers say that you will always have a car payment. How much of a payment you have is another matter. If you want to take on a car payment, have a written budget outlining what gets spent on everything before you go to the car dealership. Consider carefully what you can spend and don't be tempted to exceed that amount per month. Get a car loan of no more than three to five years. Credit card debt, on the other hand, is generally considered a bad idea, yet millions of people carry credit card balances with high interest rates. If you choose to do this, rely on a written budget to let you know what is reasonable for your income.
Debt-Free Living
Many people choose to live debt-free lives, or at least free of debt except for a mortgage until they pay that off. The disadvantages of this lifestyle are that you may have to defer purchases until you can afford to pay cash for them and that you will not maintain your credit or FICO score. The advantages of a debt-free lifestyle are many. When you are not making debt payments, your income is freed up to invest and build wealth. You can save up for things that you want more quickly because you are not paying debt. Debt-free people have less stress about finances in general. For people who choose to live debt free, no debt is reasonable.
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