Monday, April 13, 2015

The credit card debt mystery

It's Financial Literacy Month, and debt is on everyone's mind. Not that all debt is necessarily bad, because without some you won't be able to establish a credit history to make larger purchases in the future. Much of the focus around this time is how to manage debt, so that you, the consumer, can make purchases but be able to pay them off on time, avoid needless interest payments, and sleep better at night.

I mentioned before how some gurus in the field encourage their followers to avoid credit cards. I've argued then as I will now, that type of advice is not only unhelpful but also unnecessary. Credit is not the issue, but the lack of discipline many consumers face to manage their debt wisely. We all fall on tight or hard times, but credit cards did not get us there. As business entities, financial institutions will advertise aggressively, just as any business aggressively advertises its products. It's up to consumers to learn to avoid the lure of the next greatest and newest products.

But we are still faced with a credit crisis. Today's generations are holding a lot more debt than prior generations ever were. Those born in the early to mid 80s have over $5,000 in debt on average than their parents did and $8,000 more on average than their grandparents' generation. The biggest difference between these three generations is that the older ones only purchased what they could pay for in cash.

Where there is a large problem with credit card debt is among the low and middle income families, who rely on credit card purchases to pay for items they couldn't otherwise afford. A new study has found that a lot more working class and professionals are on public assistance than has been assumed. We find ourselves back at square one: that most consumers are having to abuse credit card purchases and drive themselves into debt.

I'm not attacking credit card users, but merely trying to make sense of the credit card debt mystery. Debt has always been around. In fact, it's been traced as far back as the Roman Empire. And if you have ever run a business, then you understand that some debt is necessary. But where do you draw the line?

  1. Understand how much debt you're actually carrying. One good measurement is the debt-to-income ratio, which as the name suggests, compares the amount of debt you're carrying relative to how much you're earning. Add all of your debts and any money you receive separately, including salary, wages, or any extra earnings or financial assistance. Divide your debt into your income. Anything below 36% means you're debt burden is still safe. Anything above that should raise a red flag, and if your ratio falls at 50% and above, you're in the red zone.
  2. Review your credit report and credit score. This is where all of your debt is collected and assigned a score, which reflects just how well or how poorly you're managing your debt. A score that falls at 750 and above is excellent credit, 620 - 745 is very good credit, and anything below 620 is considered bad credit.
  3. Good dose of common sense. If you find that you're unable to keep up with monthly payments, then its a clear sign you are in over your head. It's time to stop making additional purchases and re-evaluate your finances.
If you find yourself burdened with debt, don't despair. Understand that 1) there's a way out, and 2) you're never alone. Especially with all the help that is available to consumers to get the advice and training they need to pull themselves out of debt.

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