Personal Debt Mangement Business 219

Agenda Thumb Rules for consumer credit Signs of dangerous debt Strategies Getting out of credit card trouble Managing normal debt

General Rules of Credit Capacity Debt Payments-to-Income Ratio monthly comsumer credit payments* net monthly income Consumer credit payments should not exceed a max of 20% of your net income. *Not including house payment which is a long-term liability. Most mortgage companies will allow a mortgage payment(PITI) of 1/3 your monthly income, so long as your dept paymets-to-income ration is under 20%

Louise- Chapter 6 #2 Louise McIntyre’s monthly gross income is $2,000. Her employer withholds $400 in federal, state, and local income taxes and $160 in Social Security taxes per month. Louise contributes $80 per month for her IRA. Her monthly credit payments for VISA, MasterCard, and Discover card are $35, $30, and $20, respectively. Her monthly payment on an automobile loan is $285. What is Louise’s debt payments-to-income ratio? Is Louise living within her means?

Louise Solution Louise’s Gross Income = $2,000 Less: Income taxes = -400 Less: Social Security Tax = -160 Less: IRA contribution = -80 Net take-home pay = $1,360 Her monthly payments on VISA, MasterCard, Discover Card, and a car loan add up to $370 per month. Louise’s debt payments to income ratio is 370 to 1,360, or 27.2 percent. This ratio exceeds the recommended 20 percent figure. Therefore, Louise is overextended. Her maximum monthly loan and credit card payments should not be over $272 (20 percent of $1,360).

Kim Lee (Chapter 6 Problem 5) Kim Lee is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Kim is living at home and works in a shoe store, earning a gross income of $820 per month. Her employer deducts a total of $145 for taxes from her monthly pay. Kim also pays $95 on several credit card debts each month. The loan she needs for chiropractic school will cost an additional $120 per month. Help Kim make her decision by calculating her debt payments-to-income ratio with and without the college loan. (Remember the 20 percent rule.)

Kim Lee Solution Kim’s debt payments-to-income ratio with the college loan is 32 percent; without the college loan it is 14 percent. According to the 20 percent rule, she cannot afford the college loan. However, after Kim pays off her credit card debts, her debt payments-to-income ratio with the college loan will be 17.5 percent. Therefore, once she pays off her credit cards, she will be able to afford the loan.

General Rules of Credit Capacity Debt To Equity Ratio total liabilities = Should be < 1 net worth* *Excluding home value

Robert (Chapter 6 Problem 3) Robert Thumme owns a $140,000 townhouse and still has an unpaid mortgage of $110,000. In addition to his mortgage, he has $7,410 in consumer debt. Robert’s net worth (not including his home) is about $21,000. This equity is in mutual funds, an automobile, a coin collection, furniture, and other personal property. What is Robert’s debt-to-equity ratio? Has he reached the upper limit of debt obligations?

Robert Solution Robert’s total debt (not including mortgage) is $7,410. His net worth (not including his home) is $21,000. Therefore, his debt-to-equity ratio is $7,410 divided by $21,000, or 0.35. Since this ratio is less than 1, Robert has not reached the upper limit of debt obligations.

Wise borrowing can help you achieve your goals Wise borrowing can help you achieve your goals. But BAD DEBT can be a road to financial ruin Bad debt: Credit cards as tool for deficit spending Violating #1 rule of financial success = spend less than you earn Supporting lifestyle one cannot sustain 1.7 million Americans filed bankruptcy 2003

National dilemma non-mortgage debt This includes auto loans and credit card debt Averages almost $19k/US household in 2005 Average credit card balance = $12k (for those who carry balance 30 years and $16k interest charges to retire that $12k (13.9%, no new purchases, minimum monthly payments)

Signs of credit trouble (if one or more of these applies to you, time for action) “Maxed” out on one or more credit cards Making only minimum monthly payments Applying for new cards and taking cash advances to pay existing cards Missing payments and/or constantly late Using credit cards to by essentials (groceries) because you cannot afford to pay with cash

Corrective Action – Consumer Debt Plan of attack Put away credit cards – use cash only (includes debit card/checks) budget. Can’t afford to pay cash? Don’t buy it! Make a debt list- rank consumer debts from highest interest rate to lowest (not by balance size). Post the debt list where you see it daily Ask creditors for lower rate (if denied, tell them you will move balance to another account)

Target highest interest rate first Make minimum payments on all accounts except the highest interest rate account. Put every extra dollar towards that account until you pay it off Cross it off and note the date Move to next highest account

Debt plan of attack (continued) Consider Taking home equity loan or refinancing mortgage. This will not be effective if you run up credit card balances again. Asking for help. National Foundation of Credit Counseling (800 388-2227)

Managing normal debt Financing decisions for homes, cars, education, Assess consequences of debt (use ratios in your assessmenbt) and other means of financing Plot out options and choices on your personal financial statements

Need Motivation, Inspiration? Read, George Clasons, The richest Man in Babylon, Signet paperback ISBN 0-451-16520-9

Review Thumb Rules for consumer credit Signs of dangerous debt Strategies Getting out of credit card trouble Managing normal debt