Credit cards, student loans, auto payments--how much do you owe to creditors right now? Is it more than it should be? What are the signs that it's time to cut your spending and concentrate on paying off what you already owe?
We all have months when we struggle to make ends meet. An emergency car repair or a trip to the doctor can sometimes strain even the most carefully planned budget. But if you can only afford to make the minimum payments on your credit card bills each month—or if you’re skipping payments on some debts—it’s clear that you’re heading for trouble. You need to limit your spending and reduce your debt so you don’t start getting calls from collection agencies demanding payment on past due accounts.
Many financial experts believe that you should have a debt to income ratio (DTI) of 36 percent. That means you limit the amount you spend each month to repay student loans, car loans, personal loans, credit card bills and your mortgage to 36 percent of your take home pay. But that’s the maximum recommended; to create more of a financial cushion, keep that percentage even lower. If you’re thinking of buying a home, calculate where your DTI will be with a mortgage payment before you even apply.
Lenders get nervous when your DTI goes above 40 percent, because they worry about your ability to repay what you owe. A DTI in that range can have a negative impact on your credit score and make it harder and/or more expensive to get loans.
There are steps you can take if your DTI is higher than what’s recommended. Think of it as putting yourself on a spending diet.
When you want to lose weight, you have to take in fewer calories than you expend each day. When you want to get your debt under control, you have to spend less than you bring in. (Of course, as with weight loss, that’s easier said than done.)
Total up your monthly bills to see how much you owe. Then compare that to the amount of money you bring home every month. If your DTI is too high, you’ll either have to find a way to bring in more money or reduce your expenses so that you can pay off some of your loans:
Once you start saving, don’t blow the money, but put it towards paying off your debt. Do you owe a lot on credit cards? Choose the card with the highest rate of interest and put extra money towards that balance each month while continuing to make the minimum payments on your other accounts. When you’ve paid off one card, move on to the one with the next highest interest rate.
If the prospect of having less money to spend is depressing, adjust your attitude. Look at your debt reduction plan as a positive move; you’re finally taking control of your life and not letting your debt control you.