What’s the Right Amount of Debt?
February 19th, 2007 Debt
It is impossible to give a “one size fits all” type of recommendation whenever you are talking about the right amount of debt for a person to assume. However, this does not mean that there are not any good guidelines at all.
Of course, lenders are more than happy to make available to you as much money as they think that you will actually repay. They take calculated risks by checking out default rates, current interest rates and carefully reviewing your credit history. As a borrower, you can actually benefit from following some of the aspects of their strategy.
Before you take out new credit you should consider what the odds of your defaulting on the repayment actually are. You do not want to factor into your decision any thoughts of deliberately defaulting or filing for bankruptcy. The consequences of your actions in such cases are rarely worth it and thus they should be reserved for a very last resort.
You should also factor in any increases in your income that you are expecting to occur. However, you need to be sure that you are actually going to receive this increase. You cannot count on a raise that you have been promised or income from a stock sale.
Another thing that you should look at are current interest rates. Try to predict where they are headed. This is difficult to be confident about but you can rely on the fact that trends generally are not random. You can usually foretell interest rates by looking at bonds, futures and other such predictors. For instance, if 6% bond options are going down, you can pretty well expect that interest rates will rise above that in the near future. This is how professionals actually determine the future direction of inflation and interest rates.
Take a moment to look at your own credit history from the bank’s perspective. Be honest in answering the question of “Would you loan yourself $10,000 at 7% for 48 months?” Do not rationalize over late payments and defaults. While you may or may not have had a legitimate reason for these things to have happened, banks honestly do not care.
Make sure that you also realistically consider your total income and expenses. While you may really want a new car, you may not be able to afford one without sacrificing your essentials and while still meeting your current obligations.
Of course, nobody is going to be able to decide for you whether it is worth taking on debt for something that you really want. However, you really should think about your decision before you finalize it. After all, impulse buying is the most common way in which credit card users find themselves getting in over their heads but if they would have saved for a year they could have had the item without paying interest. Simply stated, if you cannot truly afford the payments for an item then do not make the purchase. If you do, you will wind up in financial trouble, which will take you months, or even years, to get out of. So, think long term, be realistic and you will easily be able to decide what is the right amount of debt for you.