Hi there,
We live in a highly debt-driven environment, whether it is student loans, credit cards, home mortgage, car payments, you name it. Before we can create wealth with our savvy investments, we need to learn how to manage our debts better so that we can have the savings to invest. Here are some tips to help us manage the different types of debts.
Student Loans: if you are a student or have a student in the family (living in the U.S.), always fill out the FAFSA (Free Application for Federal Student Aid). This allows the student to apply for federal student grants, such as the Pell Grant. Grants are not loans; they are free money, and do not have to be paid back. According to the U.S. Department of Education, more than a million federal-aid eligible students did not receive grants last year because they did not fill out the FAFSA. The application does not guarantee federal student aid, but NOT applying will guarantee no free money! If you cannot qualify for federal grants, then apply for federal loans (such as the William D. Ford Federal Loan). These loans have lower interest rates and more flexible repayment plans than private loans.
Co-signing loans: Never co-sign other people's loan applications! That includes family members (in most cases). Loan applications are legally binding and you are on the hook if they miss payments. Also, the missed payments will not only affect their credit scores, but YOURS as well! If someone you care about needs financial help, it is better to lend a fixed sum of money upfront rather than to co-sign any documents. Preserve your relationships (as well as your credit score)!
Rule of Thumb for Mortgage Affordability: if you are shopping for a new home and are trying to figure out how much home you can afford, the rule of thumb is to calculate 30% of monthly income as the maximum monthly mortgage payment that you can afford. The definition of mortgage payment consists of: principal, interest, mortgage insurance, homeowner's insurance, property taxes, and anything else that you put into the escrow account on a monthly basis. If you have lots of other debts (such as student loans and credit card debts) to manage, then this percentage goes down! Why do I use the 30% rule? It's because I recommend allocation of your income as follows: 25% for general living expenses (groceries, utilities, mobile phones, etc), 25% for lifestyle expenses (clothing, eating out, etc), and 20% for savings, which leaves 30% for mortgage (or rental) payments.
Credit Cards: you should pay off credit card balances in full each month, since the interest rates are so high. But if you are not able to, then at least keep the credit usage to below 30% of total credit line. This is called the credit utilization rate, and it's closely monitored by the credit bureaus to determine the all-important FICO credit score. If you are maxing out the credit limits, that will ding your credit score immensely. If you have a habit of overspending on credit cards, then my advice is to get a secured card. It acts as a regular credit card, but you must first load it with money and can spend upto how much money remains in the account.
Avoid Overdraft Protection: if banks offer overdraft protection on your bank checking and credit card accounts, just say no! Knowing that you can 'go over' the limit, it is more likely that you will overspend! Also, overdraft means more fees to the bank. Avoid the protection and the needless temptation to spend more than it is necessary.
I hope you found this article useful. Which one(s) did you find most helpful for your situation? I am curious to find out so please reply and let us share our stories. Thanks for reading!
If you liked this article, check out my previous posts below:
Personal Finance Series #7: Stop Wasting Money!
Personal Finance Series #6: Retirement Planning
If you are also interested in learning about taxes, check out my tax series below:
Tax Series #12: Itemized Deductions - Deep Dive
Tax Series #11: Beware of Tax Identity Theft
About the Author : I am a cryptocurrency enthusiast and a U.S. Certified Public Accountant with over 15 years of experience in accounting, taxation, and finance.
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