How Much Debt Is Acceptable?
There are very few people today who are not in debt and when you consider the cost of buying a home, getting a car or helping your kids through college it is easy to see how debt can quickly accrue. But just how much debt is acceptable?
Bank, credit card companies and others are all happy to lend money, indeed a major portion of their business depends upon their doing so, and with each and every loan they make they carefully assess the risk that they are running. This risk is based upon a series of factors and will include such things as the prospective borrower’s credit history, their own current default rates and present and predicted interest rates. In other words, they do not simply loan you money on a whim, but sit down and carefully calculate the risk that they are running in doing so.
So, when it comes to taking on debt of your own doesn’t it make sense to follow the same principles applied by the banks and other lenders and assess your own financial risk in increasing your current level of debt?
Your starting point should of course be to look at your current financial position and carefully examine just how much money you have coming in and how much you are paying out each month. If your income is less than your outgoings then not only should you not take on further debt, but you should be looking at ways to reduce your current debt. However, assuming that there is some slack in your favor, where should you go next?
The next step is to figure in any known changes in your finances and the key here lies in the word ‘known’. If for example you are anticipating a profit from the sale of some securities in the next few weeks then it would be dangerous to add this into the equation. Your securities may be worth $10,000 on paper today but if the market were to nosedive next week this could very quickly turn into a lot less money.
Once you have figured in any know changes, in terms of both income and outgoings, you then need to take a look at current and predicted interest rates. Here you need to take professional advice and not simply follow a hunch. Take a look for example at the bond market and see where option prices are headed as this will give you a good indication of where the professionals think interest rates are going. If interest rates are currently at 8% and look as if they are heading down, would you want to borrow $10,000 at 9% payable over the next 3 years?
Now comes the hardest part. Having decided that you can afford to take on additional debt at this time and feeling confident that you will be able to meet your repayments while continuing to meet your present commitments, should you actually take on that additional debt?
This of course is a question which only you can answer but you need to think very carefully about whether you really need the item which is going to drag you further into debt. If it is a question of helping your son or daughter through college then you may well feel that it is a price which you are more than willing to pay, but if it is for a new car when your present car is only two years old, then are you running the risk of getting in over your head for no good reason.
The credit card companies are making a fortune today because it is all to easy to persuade people to buy all sorts of things which they do not really need and certainly cannot afford by making the whole process so simple. But, while getting into debt is easy, getting out of it is a very different story.
