Keep debt in check
When you’re ready to take the plunge, these seven debt management tips will help you keep it from running your life.
What is good debt?
But does it really have to be a good debt or bad debt?
Instead of viewing debt in black and white — as good and bad, perhaps it should be thought of as bad debt and better debt, says Tim Maurer, vice president of Financial Consulate, a Baltimore financial advisory firm and co-author of “The Financial Crossroads.”
“I don’t think we should be romantically embracing any form of debt,” he says.
Still, there are ways to keep good debt in check and to use bad debt’s powers for good. Here is a strategy for taking advantage of good debt.
Avoid blind borrowing
Even though banks are squeezing their mortgage loan limits, it’s still possible to take on too much house. Don’t be tempted into borrowing the full mortgage loan amount that the bank offers, Maurer says.
Most mortgage companies will let you take out a mortgage loan equal to 30 percent to 35 percent of your monthly budget, and he advises keeping those costs below 25 percent.
Maintenance, property taxes and homeowners insurance costs also should be factored into your housing budget, says Nessa Feddis, vice president and senior counsel for the American Bankers Association in Washington, D.C.
Make a big down payment
The two decades leading up to the mortgage crisis saw a loosening in down payment requirements for mortgage loans, from a standard of 20 percent to as low as zero down.
There’s a reason those requirements were there in the first place, and why they remain a sound idea, Feddis says.
“Down payments show you’ve got skin in the game. They also show that you can better withstand downturns in the real estate market, which invariably happen,” she says.
Don’t overextend on education
Often an undergraduate degree is the permission slip for employment. But where you earn that degree can mean the difference between an annual tuition of $60,000 for an elite private school and $5,000 for in-state institution, Maurer says.
“Education is priceless, but a college degree is not,” he says.
A more expensive education may not equate to a higher salary, especially if you enter a lower-paying field, Maurer says. Know the salary ranges for the profession you want to enter and make your college choice based not only on what you can make but also on what you can afford.
“If you want a degree in social work, you shouldn’t go to Harvard to get it because you’re not recouping your investment,” he says.
Keep business and personal debt separate
Using your personal credit card to keep your small business afloat can be a risky venture, says Jessica Cecere, regional president of the CredAbility of Palm Beach County, Fla., a nonprofit credit counseling agency formerly known as Consumer Credit Counseling Service.
“If your business fails, so will your credit personally,” Cecere says.
Borrowers also should be cautious when becoming a personal guarantor to take out a small business loan, she says. If the small business defaults on the loan, the lender can claim the borrower’s personal assets.
What is bad debt?
The term bad debt refers to borrowing to pay for items that depreciate in value, such as credit cards and auto loans.
Today’s borrowers have to toe a fine line, Feddis says. They should be wary of overextending, but they should also acknowledge that even bad debt can be good in moderation.
“When credit is used responsibly, it has great value,” she says. “It can build wealth, or be used for emergencies or for getting through a rough time. But it is important to understand what the commitment is.”
Avoid the zero percent trap
“(With car loans) there is no zero percent when, the minute you drive the car off the lot, it’s worth 40 percent less than when you purchased it,” Maurer says.
With credit card debt, borrowers will come out ahead only if they pay off the account balance before the offer period expires. If you’re even a day late on a payment, you could be charged interest retroactively on the entire cost of the item.
“I don’t think it’s worth the potential of making that mistake,” Maurer says.
Use credit cards to float expenses
Maurer suggests charging all of your monthly household expenses on a credit card that offers a cash-back program. Then, maintain a higher balance in your checking account and use that to pay off your credit card debt in full just before your paycheck hits. This means your checking balance would be low for only a day or two each month before it picks back up.
“Over your lifetime, you’ll be earning a bigger chunk of your monthly interest,” Maurer says.
This idea only works if you pay off the balance every month and on time, and if you keep more income in an interest-bearing account than you have monthly expenses. Cecere says to be sure to use only one credit card. Multiple credit cards can get you into trouble.
Set a debt deadline for credit cards
Cecere suggests paying off credit card balances within three months.
“You need to be able to pay off those debts in a reasonable amount of time and not just make minimum payments,” she says.
Better yet, Maurer says, don’t even consider carrying your balance as an option.
“Revolving credit balances are the cancer of personal finance in a household,” he says.
Cecere adds, if you can only afford minimum credit card payments, don’t add new expenses. And seek help from a credit counseling organization if you can’t make the minimum.