The last forty years or so has seen credit become more and more a part of our lifes in England. Back then only the more affluent people had mortgages and credit. Hire purchase had been around for 15 to 20 years and folks were getting to used to purchasing goods this way. Somewhere between then and now everyone started to accept credit as part of their way of life. The culture of saving up and waiting to afford something gradually disappeared to be replaced with a ‘See it, want it, buy it’ mentality. Credit has become socially acceptable and in some ways this has compounded the problems.
I have been in the position of having a credit card which I have managed well only to find that the credit company regularly increases my credit limit until it is unrealistically high. Sure I do not have to take up their offer but if I were struggling with a reduction in income it would be all too easy to grab it fast and think of the consequences later. I also find that there is a constant stream of junk mail envelopes on my doormat which when opened have offer upon offer of loans and credit.If I was to take some of these offers up, how much credit would be too much?
I suppose in some ways I am from the old school and still feel that overall any credit is too much. The problem is that any credit reduces the income you have to survive on. Allow yourself to take on more credit than you can afford and your income will be reduced so that in a worst case scenario you may have to borrow just to make ends meet.
It is much better to consider credit wisely before taking any on. Firstly make sure that the offer that seems so good is not. Some charges that apply with credit will mean that you are paying much more than purchasing for cash. Secondly is it something which you need and will value or just a whim which will soon be forgotten. Finally can you afford it.
Assessing if you can afford the amount of credit you have means planning ahead. It is no good having credit which leaves you nothing to live on or which you can only afford if you work every hour god sends. Thinking ahead means working out if you could afford your credit if you were ill for a short or long time. What about if one of you lost their job or had to take a reduction in hours? In England mortgage lenders would at one time only lend twice the main income earners wage and one and one half times their partners. I hear that now they will lend up to four times the main wage earner and 3 times their partners. This is totally unrealistic and ultimately will be impossible to maintain the payments. If you are a young couple who will be hoping to start a family in the near future these changes and extra demands on your income must be considered.
I feel that credit like everything else in life is personal and some people can cope on less money than others. However you must sit down and work out exactly what you have going out on the basics such as gas, electricity, water, council tax, food, insurances, clothes, transport, rent or mortgage and any other essentials. Many people do not actually realise until they see these figures just how much money goes out each week. You must bear in find extras such as dental treatment, prescriptions and spectacles. You will also need to take into account the usual increases which occur in your essential household bills each year.
One of the ways I have read about that you can use to calculate your debt, is by working out your ‘debt-to-income ratio’. This is the amount of debt you have set against your income. There is good debt and bad debt. When working out your debt to income ratio you can leave the good debt out or include it to see a full picture.If you want to work out just how much trouble you are in then it is often better to calculate the ratio using only bad debt.
Check out http://credit.about.com/od/reducingdebt/a/toomuchdebt.htm for more details. I found the calculation below for working out you debt percentage.
‘Let’s say you want to gauge your debt overload(bad debt only) Add the amount you spend each month on bad debt and divide it by your total monthly income. Multiply that number by 100 to come up with a percentage. The result is your debt-to-income ratio.
For example, let’s assume you make $3,000 a month but let’s also assume you spend $300 on credit card payments and $450 on an auto loan. Your ratio calculation would be $750 / $3,000 = 0.25. Multiply that by 100 for a debt-income-ratio of 25%. In this example, you would be spending a quarter of your income on bad debt.
Whether the debt is good or bad, obviously the least you owe the better. A bad debt ratio beyond 10% is classed as far too high and can be a sign that you are overloaded with debt and in too deep. This would definitely be a case of too much debt. There will be times when you want to evaluate your total debt picture, including both good debt and bad debt. The calculation is the same as in the previous example except that you include all your debt, rather than just bad debt.
To calculate your total debt-to-income ratio, add up your total monthly debt expenses. This includes payments for credit cards, student loans, mortgage or rent, child support or alimony, and other loans or credit cards. Next total your monthly income, including take-home pay, alimony or child support, bonuses, or dividends.
Divide your total debt payments by your total income (don’t forget to multiply by 100) for your debt-to-income ratio. Overall it is recommended that your total debt-to-income ratio, including good and bad debt, is best at 36% or lower. A ratio lower than 30% is excellent, while a ratio over 40% a warning that financial disaster could be just around the corner’
CONCLUSION
I found the debt to income ratio difficult to understand at first. However once you have read it through a couple of times it is really very simple. The advice is basically what I said but it gives you a range of figures to work on which will plainly show you whether you have too much debt or not. I intend to work mine out as soon as I finish this article and fingers crossed it will not be a bad result.
On the whole if you just use your common sense and always bear in mind your other outgoings it should be easy to work out what you can afford, Remember the old Mr Micawber saying from Dickens “Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.” The amounts may have changed but the sentiment remains the same.