Understand How To Manage Your Credit And Debts Better

Friday, January 20th, 2012

Credit is an important tool – it affords you the purchasing power to buy something right now but pay for it later. However, it is imperative to understand that when you buy something on credit you are borrowing the money needed to pay for it and the end result is that you are forgoing the use of a portion of your future earnings.

There are two key things to keep in mind when formulating a plan to manage your credit and debt:

1) Your debt-to-credit-limit ratio

This ratio is utilized by credit scoring agencies to analyze how well you manage your credit card debts. In the interest of having the best possible credit score, you should be mindful to keep your charges below one third of your credit limit whenever possible, and never allow your debts to amount to more than half your line of credit. The amount of outstanding debt you have as compared to your available credit comprises 30% of your overall credit score, so it is an important thing to be conscious of. Lenders consider excessive amounts of debt to be a negative indication of your financial stability and the rates and offers extended to you, if any at all, will reflect that. So make sure that you don’t max out your credit cards.

2) Your debt-to-income ratio

The totally amount of your monthly debt payment obligations, excluding what your rent or mortgage payments, should not be more than 20% of your net pay. This means the total sum of what you must pay each month on credit cards, student loans, car loans and other personal or consumer loans should be below 20% the net amount you take home each month. To figure out what your situation is, divide your net take home pay into the combined total of all your monthly debt payments not including your monthly rent or mortgage payments. If the resulting number is under 20% you are in good shape. However, if the number you come up with is more than 20% then you definitely have too much debt which means that the possibilities for you to acquire new lines of credit are limited at best.

What you should do is aggressively attack your debt by identifying the debt bearing the highest interest rate and sending in more than the monthly minimum until it is eliminated and then move on to the debt with the next-highest interest rate. You should apply any bonuses, tax refunds or other unexpected income to the repayment of your debts until you have whittled it down to less than 20% of your income.

Options If You Are Already In Significant Debt

If you are already overburdened by debt, there are several options available for you to turn to should you be seeking relief. There are not-for-profit credit counseling agencies that offer their services in most cities across the country. They will provide assistance for you in setting up a personal debt management plan. Once that is in place, your credit counselor can approach your creditor and negotiate on your behalf for a lower monthly payment amount and possible even a lower interest rate in order to enable you to make timely monthly payments towards your outstanding debt within the means of what you currently earn.

Debt settlement is an option in some cases, and it refers to when a creditor allows you to pay less than the outstanding amount in order to clear the debt. While this option may have an appealing ring to it, it has a devastating impact upon your credit score – lowering it by 100 points or more. The negative impact upon your score is due to the fact that you did not repay the loan in full as originally agreed, and a debt settlement entry on your credit report will stay there for seven years.

Bankruptcy is the final option if you are in serious financial trouble and there is no other way out. This will have an even more devastating and longer-lasting impact upon your credit score than a settlement. There are two different types of bankruptcy – Chapter 7, which will usually allow the filer to walk away from the bulk of their debt without wages being garnished, and Chapter 13 which implements a court-ordered plan to repay all outstanding debts over a three to five year time span. Bankruptcy entries tend to linger on your credit report for as long as a decade.

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