It's almost impossible to live debt-free;
most of us can't pay cash for our homes or our children's college
educations. But too many of us let debt get out of hand.
Ideally, experts say, your total monthly long-term
debt payments, including your mortgage and credit cards, should
not exceed 36 percent of your gross monthly income. That's one
factor mortgage bankers consider when assessing the creditworthiness
of a potential borrower.
It's far too easy to spend more than you can
afford, especially when you pay by credit card. The average
U.S. household with at least one credit card carries over an
$8,000 balance, according to CardWeb.com, and personal bankruptcies
have hit record highs in recent years.
Of course, avoiding debt at any cost is not
smart, either, if it means depleting your cash reserves for
emergencies. The challenge is learning how to judge which debt
makes sense and which does not, and then wisely managing the
money you do borrow.
Good debt includes anything you need but can't
afford to pay for upfront without wiping out cash reserves or
liquidating all your investments. In cases where debt makes
sense, only take loans for which you can afford the monthly
Bad debt includes debt you've taken on for things
you don't need and can't afford (that trip to Bora Bora, for
instance). The worst form of debt is credit card debt, since
it carries the highest interest rates.
Sometimes the decision to borrow doesn't hinge
on how much cash you have, but on whether there are ways to
make your money work harder for you. If interest rates are low,
compare what you'll spend in interest on a loan versus what
your money could earn if it were invested. If you think you
can get a higher return from investing your cash than what you'll
pay in interest on a loan, borrowing a small amount at a low
rate may make sense.