Before taking on more debt it’s a good idea to evaluate your current financial standing. Here are four questions to ask yourself that will help you determine if more is a good idea:
1. How much outstanding debt do you currently have?
Many people never take time to add up the balances of all their debt, but it is an extremely important step. To responsibly take more, you really need to know what shape your finances are in before accepting another line of credit. Without knowing where you stand, another loan could be disastrous to your disposable income and future.
2. Is being debt-free at retirement a possibility?
You should really aim to be debt free at retirement. That means no credit card, car, or mortgage debt. Although no mortgage may not be possible, credit card and car loan should without a doubt be paid off. To find out if you’re on track, take your total outstanding debt as of today and divide by the number of years to your projected retirement. For example: $200,000 in debt with ten years until retirement. That adds up to 25,000 in principal alone that you’ll have to repay each year. Finally, take the 25k and compare it to your total family income. How does it look?
3. What is your debt to income ratio?
To find your debt to income ratio, take your total debt and divide it by your annual, post tax income. If your ratio is in the 20-30 percent range you’re typically considered to be in good shape. Obviously, the lower the percentage, the better financial state you are in.
If your percentage is hover over 50 percent, many financial consultants would consider that disastrous. That being said, if you debt to income ratio is over 50 it’s probably not a wise idea to take on more.
4. What interest rate will your new line of credit pay?
One attribute of bad debt is a high interest rate. Credit cards are usually bad since the interest rate can run as high as 10 to 20 percent. Naturally, if you are going to take on more debt, even if you are in great financial standing, it makes sense to ensure you can get the lowest interest rate possible. A high interest rate can mean the majority of your payments go to the interest, which makes it hard to ever pay down the actual principal.
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