CHICAGO (AP) — It seems like common sense: Don't take on more debt to pay off your bills.
Yet debt-laden consumers routinely do just that,
even as they criticize the federal government for efforts to raise the debt
ceiling.
The spotlight is on the government's questionable
fiscal behavior as it nears its borrowing limit of $14.3 trillion and confronts
the risk of a crippling default. But most individuals are just as addicted to
debt as Uncle Sam.
Total consumer debt including mortgages was $11.5
trillion at the end of the first quarter. Americans then piled more on to
credit cards in April than in any month in three years.
We've been on a personal debt binge for a long
time, in fact. The last year households carried less debt than their disposable
income was 2001, according to the Bureau of Economic Analysis.
Like the government's situation, it's past time to
attack debt more aggressively and slash spending to get it down.
"It's time to look in the mirror and think
about modeling the kind of behavior we want from our country," says
Eleanor Blayney, consumer advocate for the nonprofit Certified Financial
Planner Board of Standards. "Our government's situation reflects where we
are individually."
These five essential tips for managing debt can
help you avoid potential pitfalls:
1. Keep a lid on total debt.
A good benchmark for your personal debt ceiling is
to limit total debt to no more than 40 percent of your gross income. When
households have to pay more than that every month it's generally an indicator
of financial distress, according to the Federal Reserve.
The National Foundation for Credit Counseling has
another way of framing it. Housing, including a mortgage, should account for no
more than 30 percent of your take-home pay, according to spokeswoman Gail
Cunningham, and all debt obligations such as credit cards and car payments
should total no more than 20 percent.
Even if you stick to that, Cunningham cautions,
you've spent half your income but you haven't eaten or put gas in your car.
"Stretching yourself beyond those limits isn't going to work."
2. Understand how your credit report can affect
your life.
Having good credit in this tight economic and job environment
is more important than ever, and with more far-reaching consequences.
Without it, says Blayney, it can be difficult to
get hired or rent an apartment because employers and landlords now commonly
look up credit reports. About six in 10 employers conduct credit checks,
including 13 percent that do so for all job candidates, according to survey
data from the Society for Human Resource Management.
Carrying a heavy debt load can have a significant
impact on your credit score, not to mention squeezing you financially and
leaving you more vulnerable in emergencies. But abstaining from all use of
credit cards can be harmful to your score, too, and make it more difficult when
you might need a loan.
3. Remember that "good debt" isn't as
good as it used to be.
Student loans and mortgages are considered good
debt because borrowers generally end up making money from their investment.
That can still be the case, but it's hardly a sure thing.
Even though a college education may pay off
financially in the long run, today's graduates can end up with low-paying jobs
or none at all in an environment where unemployment is 9.2 percent. That can
make heavy student loan obligations all the more difficult to pay off,
tarnishing a job-seeker's credit report and compounding the challenge of
finding work.
What's more, home equity is shrinking as housing
prices continue to fall, nudged lower by all the foreclosed homes being dumped
on the market. Prices in major metro areas sank to their lowest level this
spring since 2002, and the outlook elsewhere isn't much better.
Good debt now, Cunningham says, is any debt that
you can responsibly service.
4. Don't take on credit card debt that will linger.
Part of keeping debt from mounting has to do with
not just making the minimum payments. Those now-required monthly updates from
your lender telling you you're on pace to pay off your credit card in 23 years
should help remind you to pay more. The average interest rate on credit cards
with variable rates is 14.42 percent, according to Bankrate.com.
Excluding your mortgage and car payments, the
target should be to have no more consumer debt than you can pay off in 12 to 18
months, says financial planner Jeff Kostis, president of JK Financial Planning
in Vernon Hills, Ill.
"If you have to go beyond that, you've really
taken on too much for your budget and your lifestyle," he says.
5. Pay attention to fees and fine print.
Consumers who aren't careful can end up paying a
significant amount in hidden fees and other costs when they use credit.
Banks looking to make up for revenue lost when
Congress tightened credit card policies in 2009 are looking to partially
compensate through new or increased fees. There can be fees for phone support,
foreign transaction fees, over-the-limit fees and even inactivity fees. So when
using credit, make sure you understand all the fees and penalties you might be
subject to.
Copyright 2011 The Associated Press.
(AP
Photo/Gene J. Puskar, file)
