| HOW MUCH DEBT CAN YOU HANDLE?
Q. What are the costs to me or my family of becoming over-indebted?
A. First, as we have learned from the section on credit reports,
your creditors will report your
delinquencies to the credit bureaus. As a result, you will have difficulty
in obtaining more credit
or keeping the lines of credit that you now have on your credit cards.
Some may be canceled or not renewed on their renewal dates. If you are
already over-indebted, that result may not be
entirely bad. But when you really need a good credit record to rent an
apartment, to get a home mortgage loan, or to get a new job, having a
bad or even a weak credit report can hurt.
Also, as you will see in the next section, you will be the target of vigorous
collection
efforts, from your creditors and ultimately from professional collection
agencies. These people
want to recover the money that you owe and will write you and telephone
you frequently.
Finally, there is the ultimate possibility of bankruptcy, which is discussed
in the next section. Regardless of what you might be told by others, that
is not a pleasant experience.
Moreover, the record of your having filed for bankruptcy stays on your
credit record for ten
years, and can handicap your access to various forms of credit for much
of that period of time.
Q. What guidelines are there for how much debt I can handle?
A. As a rough guideline, one long-standing rule is that if your
monthly payments on debts,
excluding your home mortgage payment, exceeds 20 percent of your after-tax
or take-home pay, you most likely have reached your debt limit. Or, to
put it another way, a roughly equivalent debt limit for those same credit
payments is 30 percent of your pretax income. Since less than 3 percent
of American families find themselves with payments at 30 percent or more
of their gross income, you can see that relatively few families permit
their debt burdens to reach or exceed that limit.
Q. Are there danger signs that I am heading for debt troubles?
A. Aside from the percentage of payments to take-home pay or
gross income, there are some
very reliable danger signs:
• you are making only minimum monthly payments on your credit card
accounts;
• you have to use credit for expenditures that you once paid cash
for;
• you have used a series of consolidation loans, home equity loans
or other types of loans to
pay overdue bills;
• you are borrowing from one lender to pay another; for example,
you take a cash advance on
your bank card to pay amounts owed other banks or retailers;
• you begin to run a few days late on critical payments, such as
your rent or mortgage
payment, or you are consistently late with all your bill payments so that
late fees are piling
up;
• you dip into savings for normal living expenses.
Q. So, what do I do when I see one or more of these danger signs?
A. The first step is to slow down on use of credit. If you are
going shopping, take only the one
credit card that you will need, or try using cash instead of credit cards.
Cut up excess credit cards and return them to the creditor asking that
the credit bureaus be notified that you have closed the account.
Next, find out where you money is going by keeping track of family purchases
for just two
weeks. If you start out the day with thirty dollars in cash and end with
five dollars, where did the twenty-five dollars go? To the twenty-five
dollars add any credit card slips from credit purchases during the two
weeks. Keep track of these money outflows for just a couple of weeks and
then
have a family conference to discuss how those outflows can be reduced.
Now is the time to begin
financial training for teenagers and even younger children.
Once you have a good understanding of where the money is going, you may
find it useful
for the family to prepare a cash budget that will show the highest monthly
payments you can
afford on your debts. A rough outline is show below; it can be as fancy
or simple as you want it.
_________________________________________________________________
Family Cash Budget
You and your spouse's
monthly take-home pay __________
Other income __________
A Total monthly income __________
Your monthly expenses:
Food __________
Rent or mortgage payments __________
Utilities __________
Telephone __________
Transportation (gasoline,
mass transit costs) __________
Itemize other major categories __________
Regular monthly savings __________
B. Total outlays __________
Your annual expenses:
Taxes __________
Insurance (not paid monthly) __________
Medical and dental bills __________
School costs __________
Entertainment __________
Clothing __________
Itemize other major categories __________
Total annual expenses __________
C. Total annual
expenses divided by 12 __________
D. Monthly income available for
payments on debts: __________
(A - C)
Income already committed
to monthly payments:
Personal loans __________
Auto loans __________
E. Committed income ___________
Discretionary income (D - E) ___________
______________________________________________________________
A few comments on this budget may be helpful. It is easy to overlook annual
expenditures and then be hit with a cash crisis when an insurance bill
comes due. Also, it is easier to decide on a budget for clothes, recreation
and such on an annual basis and then divide the total by twelve to get
a rough estimate of acceptable monthly outlays. The trick is not to spend
the annual budget in the first two months.
Note that savings are budgeted as a monthly expense. If we don't budget
it, we won't
save. Savings are for two purposes. First, to set up an emergency fund
in case somebody is laid off or becomes ill. A rule of thumb is that an
emergency fund in the form of savings or other
readily accessible assets should equal three to five months of after-tax
income. Second, once you have set up an adequate emergency fund, the saving
is for retirement, to build a college tuition fund and to meet other long-term
goals that the family may have. These rules, however, should take into
account any sick leave and retirement programs you have through work.
You may have wondered why the section for payments on "Income already
committed on
payments" did not include payments on your credit cards. Expenditures
on credit cards have
already been included in the budget allowed for clothes, entertainment
and the other expenditures for which you use your credit cards. If you
live within your budget for those expenditures, you will be able to make
those payments.
Finally, many families may find that the difference between the amount
on line D:
"Monthly income available for payments on debts" is less than
the amount on line E: "Income
already committed on payments." This result means that income must
be increased or
expenditures cut.
Go back and look at a two-week record of cash outflows and see where you
can cut
spending, so that you can free more money to meet your monthly bills.
Add up all of the costs of going bowling once a week or pursuing some
other hobby. Consider writing letters rather than making long-distance
calls. Adopt the industry approach of "zero-based budgeting."
Show a real need for any expenditure above zero. In addition to cutting
cash outflows, you may be able to improve cash inflows. For example, a
spouse or teenager might take a part-time job.
If you are not able to meet your monthly payments, you may want to approach
one or
more of your creditors and try to reduce or defer monthly payments without
having to pay a
penalty. Simply be honest in explaining your cash flow problem and ask
the creditors if they can
help you get back on your feet. While there is no guarantee that creditors
will agree to this
arrangement, the worst thing that you can do is to try to avoid them or
to make promises to pay
that you don't keep. If these self-help efforts don't do the job, you
may want to contact a
consumer credit counseling service that can help you set up a new budget.
These are discussed at the end of this section.
What if You Don't Pay Debts As Promised?
The law allows credit grantors various ways of collecting unpaid debts,
some of which depend
upon the law of the state in which you live. They may be able to seize
part of your wages or the car that you purchased on credit. Or, they
may rely on debt collectors. The law attempts to balance the rights
of the credit grantor who provided the credit and the rights of consumers
who used it but did not fully pay for it. If you have successfully
managed your finances as explained in the previous section, you can
skip this section. |
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