Thinking of taking on debt? For example, opening a credit card or purchasing a car or home? Unsure how much of it is too much? This is quite an ambiguous question because many have different opinions on debt. Some believe having it is taboo, even when it comes to buying a house. Others believe it’s fine to have debt as long as you can afford the payments.
Credit and debt go hand-in-hand. Credit is a financial device such as a car loan, mortgage, or credit card that people can get from a credit union or other financial institution. Credit serves as a source of funding when you don't have enough cash or assets to pay for things you want or need. (a car, a home, college education, etc.). Debt is what you owe after obtaining credit.
The amount of debt you can and should take on depends on your situation. Current living arrangements, current debt, your spending and saving habits, and how much you’re getting paid are some factors that go into deciding how much debt is too much for you.
According to CFA Elvis Picardo, a good rule-of-thumb to calculate a reasonable amount of debt would be to use the 28/36 Rule. This rule suggests that households shouldn’t spend more than 28% of their gross income on housing expenses (including mortgage payments, home insurance, property taxes, and condo fees), and a maximum of 36% on total debt service (housing expenses + other debt). For example, on a $40,000 salary following the 28/36 Rule, housing expenses should not exceed $11,200 for the year or about $933 monthly. Other personal debt should not exceed $3,200 annually or $267 monthly. Use this rule as a starting point to calculate your reasonable debt load.
Now that we’ve covered one big purchase let’s focus on another: your car. When deciding how much car you can afford (not how much you should spend on a car) it all depends on your needs, lifestyle, and how much you take home. According to www.moneyunder30.com, there are three answers to the question of how much car you can afford: the frugal answer (10% of income), the compromise (20% of income), and car lover (spending more than typically recommended for most people, perhaps up to 50% percent of your income).
If your car needs aren’t excessive and you just need a “beater” that goes from point A to B, then the frugal approach suggests between 10-15% of your salary should be how much you spend on a car. For example, if your income were $30,000/year, a good rule-of-thumb would be to purchase a car that’s between $3,000-$4,500 likely with high mileage.
This must all sound really conservative to you right now, but let’s compromise. What if you’re looking for something a little bit more reliable and safer to accommodate family needs? You’d probably want something newer that’ll last longer, right? For a more reliable, newer car, 20-25% of your income would be a good benchmark. If you make $30,000 a year, you’d be spending between $6,000-$7,500.
I know there are some readers still thinking even that is too strict and unrealistic for their car needs. Well, if you have a passion for cars and value cars more than other items, you may fall under the “car lover” category. The www.moneyunder30.com blog gives the OK to spend up to 50% of your income on your car, but only if you can afford it along with your other expenses. Just be cautious. If your car is your largest expense, be weary of other expenses.
Be mindful of your financial situation as a whole before you apply for a loan and go into debt. If you’re able to afford the payments, are confident you’ll get a return on your investment, and qualify for a good interest rate, then debt is very much a tool at your disposal. Great interest rates on mortgages can land you a profitable home if it appreciates in value over the long term. Getting a student loan to beef up your knowledge and can earn you more income over your lifetime.
Most credit unions have competitive interest rates on mortgages, student loans, car loans, credit cards, and more. Find a credit union that can provide you with the tools to grow your worth over your lifetime at www.bankingyoucantrust.com.