Money and credit are what drives the world and using these tools effectively will make your own life financially sound. Consumers who follow common sense money rules for debt avoidance will reject the temptations of instant gratification that credit cards offer, and make use of good debt that can pave the way for a comfortable retirement.
Living Beneath Your Means
The essential rule of smart debt management is to live on a budget that's beneath your means. Lenders often approve credit lines and loans that are much greater than you can actually afford to spend. Just because you were approved for a $5,000 Visa card doesn't mean you should charge it up every month, even if you can pay it off in full. Saving toward a rainy day fund is a wiser use of your spare funds, and will come in handy in the event of an emergency -- or investment opportunity. Plan to set aside six months of emergency funds, if possible.
Mortgage Debt
Examine the debt rules that mortgage underwriters consider when reviewing home loan applications. These rules, known as front- and back-end ratios, provide a framework for the maximum amount of debt that a consumer should have, given income constraints. The rules state that no more than 28 percent of pretax monthly income should be used for housing -- including taxes, insurance, and association fees. This percentage isn't the target, rather it's the maximum amount allowable and is the front-end ratio. Borrowers usually have other debt, therefore the total of the housing debt plus other debts shouldn't exceed 36 percent of pretax monthly income. This is the back-end ratio.
Credit Card Debt
The temptation to overspend with credit cards can be overwhelming. Do yourself a favor and keep your limits small. Don't use more than 30 percent of your credit limits, and train yourself to walk away when tempted with an impulse purchase. Avoid charging essentials. Always pay your bills on time, and preferably, in full. Keeping your credit score high earns you the most competitive interest rates on mortgages and auto loans, two common types of good debt.
Retirement Versus College Savings
College costs can easily exceed $200,000 for America's top private schools. However, sound debt management states that you shouldn't borrow more than what the student can expect to earn in the first year of employment. Is your student willing to pay possibly tens of thousands of dollars toward his education? If not, consider your question answered. Put your savings toward your own retirement first, and college, second. You may be able to borrow against your 401k for college at an interest rate that's lower than what a bank would offer and you'll be paying interest to yourself instead of a bank.
Paying Off Debts
Pay your highest interest loans first; this approach saves the most in interest charges. Ramp up your monthly payment on one debt only by making much larger monthly payments while paying the minimum on the others. When the first debt is paid, add that payment to the next debt. Common sense money rules are all about modesty, patience, discipline, and delayed gratification. Practice these traits and your reward will be a comfortable retirement.
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