In a perfect world, you’d be debt free. If you must borrow money for purchases, stay within following guidelines. These guidelines will allow you to meet your obligations and still leave you money for investments, charitable giving, vacations and other expenses.
Debt Guideline #1: Your Total Debt Payment.
Your total debt payments, including your mortgage payment, should not exceed 30% of your take home pay.
Debt Guideline #2: Buying Your Home.
One of the biggest mistakes you can make is buying a home that is too expensive. Typically, mortgage bankers will allow your mortgage payments to equal approximately 35% of your take home pay. This is considered the maximum amount banks can safely lend without eventually having to foreclose on the home. However, spending 35% of your take home pay on mortgage payments will strain your budget and not leave enough free cash flow to easily meet other living expenses.
Your total house payment, including taxes and insurance, should not exceed 25% of your take home pay. The ideal home mortgage payment is actually a range of between 15% and 25% of take home pay.
If you have a high degree of job security and you expect your income to steadily go up, you can use the 25 percent figure. However, 20% is the ideal maximum for most people. At 20%, there should be plenty of money left over to meet other lifestyle expenses as well as savings and investment needs.
Use 15% if you are more conservative and cautious or are uncertain about your job security.
Debt Guideline #3: Buying Automobiles.
You’ll probably spend more money buying cars than on any other consumer purchases during your lifetime, including homes. You should strive to avoid a lifetime of auto loans.
Do not finance automobiles for more than 24 months. Let the payments you can afford over 24 months determine how much you can afford to spend on a car (probably a used car).
At the end of that 24 months, continue to make your car payments – to yourself, into an Investment Account. Continue to make payments while you drive your existing car. When you have accumulated enough money to pay cash for your next car, then buy another car. By continuing this process throughout your life, you will eliminate car payments and the thousands of dollars in interest expense associated with them.
Debt Guideline #4: Installment Debt for Consumer Purchases.
Purchases bought on installment payments include furniture, appliances, home repairs such as a new roof, etc.
For surprises such as a furnace gone bad, you should have an emergency fund. For all other purchases you should save until you have enough money to pay cash. When these two solutions are not practical, use the following guideline for borrowing
Installment debt payments should not exceed 12-24 months. Smaller purchases such as a washer/dryer should be paid off within 12 months. Larger items such as a new furnace or roof may take 24 months.
Debt Guideline #5: Credit Cards.
Credit cards are too easy to get and to use and they’re very hard to pay off! You cannot afford to pay 18-21% interest on any amount of money. Therefore, you must pay off your credit charges at the end of each month. The best way to avoid credit card problems, is to enter your credit card charges directly into your checkbook register and subtract the balance just as you would a check. Think of your credit cards as part of your overall checkbook system.
Summary Guidelines for Using Debt
To achieve financial independence you must take control of your debt by staying within these guidelines:
Home mortgage payments should not exceed 25% of your take home pay.
Other debt payments should not exceed 15% of your take home pay.
Total combined debt payments (mortgage + consumer) should not exceed 30% of your take home pay. For example, if your mortgage payment equals 20% of your take home pay, you must limit other debt to 10% so that total debt payments do not exceed 30% of your take home pay.