The Right Amount of Debt?Debt Counseling
No 'one-size-fits-all' recommendation is possible when considering the right amount of debt to assume. But that doesn't mean there are no good guidelines at all. Naturally, credit card companies and other lenders are happy to make available as much money as they think their borrowers will repay. They take risks, but those are calculated risks. They look at default rates, current interest rates and carefully review credit history when they make loans. Borrowers can benefit by following some aspects of their strategy. Before taking out new credit, consider the odds that you will have to default on repayment. Don't factor in to your decision the possibility of deliberately defaulting or filing bankruptcy. You'll find the consequences are rarely worth it and that should be reserved as a very last resort. You can factor in expected increases in income - banks and other business do - but you should be very sure you're actually going to receive it. A promised raise or hoped for income from a stock sale is far from guaranteed money. Look at current interest rates and make a prediction about where they are headed, businesses do. That's a very difficult thing to be confident about, but general trends are not random. Look at bonds, futures and other indicators. If 6% bond option prices are going down, many pros are betting interest rates will rise to above that in the future. These represent the opinions of professionals about the future direction of inflation and interest rates. Look at your own credit history the same way a bank would. Try to see it from their perspective. Would you loan yourself $10,000 at 7% for 48 months? Avoid rationalizing late payments or defaults. You may have had a legitimate reason, or you may not yet have developed the resources (inner and financial) to repay all your loans on time. Consider your total income and expenses realistically. You may really want a new car, but can you afford an extra $500 per month without sacrificing essentials while still meeting your current obligations? Be honest with yourself. No one can decide for you whether it's worth assuming an ongoing $200 per month credit card payment at 12% in order to have an item you've been longing for. You may value having the item today more than you value the extra money it will cost you over what you save by saving for it. But you should at least think about it. Impulse buying is the most common way credit card users get in over their heads, financially speaking. Project the possibility that if you wait (and saved for, say, a year) you will have both the item and something else you can purchase with the money you would have paid in interest. Evading the fact, if it is a fact, that you can't really afford the payments is the surest way to get into financial trouble. That kind of trouble can take months or years to get out of. Think long term, be realistic, and you'll be able to decide what is the right amount of loan responsibility for you. There are multiple ways to reduce your total (and monthly) financial load, some less painful than others. The obvious one, of course, is to simply pay down your loans. That can be difficult, and for some it may seem hopeless. But there is one method that has been employed by many with great success: the snowball method (so named by financial guru Dave Ramsey). The technique is, in essence, very simple. Order your bills from lowest to highest. Pay the minimum required on all monthly billing statements, then allocate any remaining funds you can to paying off the smallest debt. Thus, the smallest loan will get paid off first. This frees up yet more money to apply to the next-smallest (now the smallest) account. Repeat until you have reached the level you want. This method has several advantages. You see regular, visible progress in reducing your financial burden and in a relatively short period of time you could well be down to a livable level. As you pay off those creditors, you have more free income which can be split between payments on the bill next in line and the enjoyment of some rewards. Psychologically, this helps keep the consumer motivated to continue the program. Seeing real progress helps one stick with it during a financially challenging period. But, for all its virtues, the method does have one real drawback. It actually requires more time (and money) overall to pay off all your bills that way. The reasons have to do with how interest compounds. If you pay off a $1,000 debt, a $2,000 debt and a $10,000 debt they may all have the same rate of interest. But paying off the lowest amount first actually costs you more in total interest paid. Since any outstanding amount is charged at the same rate of interest, the higher amount will incur the largest charge. As a result, over time, you will pay more in total interest charges. Reversing the order, paying the highest amount first, actually saves you money in the long run. As you pay down the highest debt first, you are reducing the amount of interest dollars paid over time. The difficulty is that the latter method, though more cost effective in the long run, is harder for most people to stick to. It takes a lot of discipline to live with that debt burden as you slowly reduce the $10,000 debt. At most interest rates, the lower debts will actually get paid off first. But in the meantime you are making high monthly payments. That takes a lot of willpower every month. That willpower is the one thing that a lot of people too deep in debt find hardest to generate. It's the factor, often, that led to excessive debt in the first place. For such people, using the snowball method may well be an advantage, despite the larger total amount paid out over the life off all the money owed combined.
Credit Repair
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