Financial Fitness Challenge, June--How Deep Is Your Debt?

by Susan Tiffany, CCUFC

Introduction

How much debt is too much? If you can pay it back--eventually--does it matter?

If you have a heavy debt load, it matters because your options get fewer and fewer. Run up against a setback and, because you have no savings, you have no choice but to use credit. The hole gets deeper. It becomes even harder to save money because you must put more of each paycheck toward paying off debt.

If you've been with the Financial Fitness Challenge since January, you know that we've twice encouraged you to check your credit report. That's just one measure of your creditworthiness. Another one is your debt-to-income ratio--what percentage of your income is debt-dedicated.

What is a debt-to-income ratio?

It's a simple way to compare your earnings against your spending. Add up all your monthly debt obligations--credit cards, students loans, mortgage, car payments, and so on. And then figure your monthly gross income--that is, before taxes are taken out. Now divide your monthly debt payments by your monthly gross--that's your debt-to-income ratio.

Lenders, for years, have looked at debt-to-income ratios to get a better idea about a person's financial picture to determine creditworthiness.

When do I need to know what my debt-to-income ratio is?

Say you want to buy a house. Most lenders look at what's called the 33/38 guideline, meaning that all your housing costs--including principal, interest, property taxes and property insurance--shouldn't be more than 33% of your gross income. And all your debt, rolling in your car payments and credit cards, for instance, should be no more than 38% of your gross. This is a common guideline, but your situation can change it, for example, if you have a large down payment or are in a career where you normally expect to see a rapid rise in income.

Is buying a house the only time I need to know that ratio?

I like to check it for my own use--it's a way to take the pulse of my debt level. When I'm meeting my savings goals, my debt-to-income ratio is where it should be, and my net worth is growing, I know I'm improving my financial fitness.

Whenever you anticipate a major credit purchase, or adding a new credit card, check the debt-to-income ratio. Another trigger--when you have a life change such as marriage, new child, job loss, for example. If you're concerned about your credit management, ask someone at your credit union for guidance or for referral to a credit counseling agency.

High debt or low balance first?

Your debt-to-income analysis might reinforce your intention to pay down debt. Which is best? Pay down bills with high interest first, or those with a low balance? Consider a few things.

If you have a few bills with small balances--something you can pay off in a few months--pay those first to simplify things and give yourself that sense of accomplishment. Once paid, you can add the amounts you previously paid on those small-balance bills to other debts. Turn your attention to the debts with the highest rates of interest--they cost you the most.

If you don't have any small balances, get to work right away on the high interest debts. We have a calculator that can help you optimize debt payments.

June basic maintenance

We've been encouraging you since January to check your free credit report as part of the Financial Fitness Challenge. What if you find a mistake? It's not uncommon and not too surprising, considering how many people are in the system. The Fair Credit Reporting Act requires credit bureaus and organizations that supply information to them to correct the mistake. But you have to request an investigation first. Here's what to do:

• You can file a dispute online, by phone, or by certified letter. A letter should include: 1) Your complete name, address, date of birth, and social security number. 2) The name of the company you have a dispute with and account number of the disputed item. 3) The reason for your dispute, any corrections to your personal information, and a request for correction.
  You can dispute an error on your credit report; start by requesting an investigation.

• The credit bureau must delete disputed information that can't be verified. If an investigation isn't resolved in your favor, ask the credit bureau to include your version of the dispute in your record.

Accurate negative information usually stays on a credit report for seven years, 10 years if you've filed bankruptcy. If the blemish on your report is accurate, you'll have to live with it.

The best way to repair your credit is to keep paying your bills--always on time--and start building a spotless record.

Fickle Finger of Fate

Uh-oh. Here comes the Fickle Finger of Financial Fate. Just when your family is all set to depart in a few days on a cross-country car trip to visit Aunt Wally and Uncle Clyde, the engine overheats and implodes. Cost to replace it is in four digits. Can you fix it--and still make your trip?

What are your financial options? Tell us, and other readers--on the Challenge's reader message board.

ST
Susan Tiffany, CCUFC
askem@cuna.coop

Published June 1, 2007, Reviewed January 14, 2008

Printed Sunday, July 6, 2008

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