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A Message from Kimberly Clouse, Financial Expert:
I have worked in the financial services industry for
nearly a decade in many capacities, most recently as
a financial advisor for individuals. Over the course
of my career, I have had the privilege of working with
a diverse range of people, from the single mother just
starting her own business to the dot.com billionaire.
Based upon my experiences, I have learned that the same
basic principles and lessons apply to a successful and
healthy financial life, whether you're starting out
or cashing out. These guiding principles include simplicity,
a long-term perspective, and above all, knowing that
you have control of your financial destiny, and all
the information you need is well within your reach.
Credit Check
- Do you use credit cards for items that you used to buy
with cash?
- Are your monthly installment bills, besides rent or mortgage,
more than 15% of your take-home pay?
- Are you at or near the limit on your credit cards?
- Do you usually pay only the minimum due on your credit
cards?
- Are you typically late in paying your bills in general?
- Are you unsure as to how much you owe?
- Do you dip into savings to pay regular bills?
If you answered "yes" to any of the above questions, it
might be time for a credit check. Credit represents a contract
between you and a vendor based on your promise to pay in the
future for goods, services, or money received today. Like
all financial instruments, credit has pros and cons, but if
you fail to manage your credit wisely, you may end up in a
difficult financial state, particularly in today's credit-oriented
society.
The Upside of Using Credit:
- More convenient and safer than cash, especially when traveling.
- Handy in case of short-term emergencies, such as unforeseen
medical bills or car repairs.
- Helps establish a credit history.
And the Downside:
- Access to money is so easy, it's tempting to overspend.
- Costly (in terms of interest and fees): if you only make
the minimum payments due, you might ultimately pay back
2-3 times the original cost of the item purchased on credit.
- Can negatively impact credit history if payments are not
made or if total outstanding debt is too high.
Your Credit Check
So, how much debt can you handle comfortably? How do you know
if you are in danger? The Consumer Credit Counseling Service
suggests that no more than 15% of take-home (i.e. net) pay
should be committed to monthly debt payments, not including
home mortgage payments.
Use these 3 steps to conduct your credit check and calculate
your debt-to-income ratio (Note: this methodology assumes
that disposable income and expenses do not vary notably from
month to month.):
- Approximate your monthly disposable income or net take-home
pay. This amount should include all income, minus taxes
withheld and contributions to various personal retirement
and investment plans.
- Estimate your monthly debt payments, excluding your mortgage.
Be sure to include credit cards payments, car and student
loans, etc.
- Divide your total monthly debt payments by your net pay
to calculate your debt-to-income ratio. If your ratio is
less than 15%, you have passed your credit check. If your
ratio falls between 15% and 20%, be cautious. You are not
in credit trouble yet but are on the borderline. If your
ratio is over 20%, there may be cause for concern. Your
credit check indicates that you are "ill" and should visit
the credit doctor. (Contact information for sources of credit
help are listed below.)
Credit Check: An Example
If you earn $25,000 annually and fall into the 18% tax bracket,
your net pay will be $1,708 per month. ($25,000/12 months
= $2,083 monthly salary. Less taxes @18% of $375 = $1,708
net pay.) If your monthly car payment is $200 while your monthly
credit card payment is $40, then your total debt payments
equal $240. Your total debt-to-income ratio is 14.1% ($240/$1,708),
which is considered a "safe" level.
These ratios are simply guidelines, and your personal situation
will, of course, be unique. For example, if you are the only
income-earner in your family, you might consider a 10% debt-to-income
ratio as a more comfortable target.
Where to Go for Help
If your debt-to-income ratio is over 20% or you think that
you are drowning in debt, there are agencies that can help.
The National
Foundation for Credit Counseling (301-589-5600) is a nonprofit
education foundation dedicated to advancing consumer literacy.
Call NFCC to find out about your local nonprofit Neighborhood
Financial Care Center. Another good source is Consumer
Credit Counseling Services (800-208-CCCS), a privately
funded non-profit agency that provides confidential financial
counseling and education about debt, credit, money management,
budgeting, and housing issues.
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