Before you make another major purchase, do some calculating.
You just bought your dream car. And you’re still making the monthly mortgage payments on your dream house. Now, you hear the latest model of the home theater equipment you’ve been dreaming about is being sold at a special introductory price at the mall.
Before you rush off to the mall and whip out your already overused credit card, sit down at your desk, do some thinking and start calculating. Do you know how much you current owe on your credit cards, to your bank, your mother or your friend? If you are like most people, chances are you don’t know. It’s also likely that you’re underestimating the interest rates you are paying.
The first step to preventing your debts from weighing you down is to learn how to priority them. To do so, compile a list of your credit card, mortgage, auto and other loans along with their balances, interest rates and monthly payments.
Add up the minimum monthly payments on all of your loans and figure out how much more you can afford to pay each month. Apply that additional payment to the highest rate debt on your list; when it’s paid off, choose the second highest rate loan as your next target.
It’s smart to have your personal budget at the start of the year to project how much debt you can carry. Unless you have offsetting assets and savings, your mortgage payment shouldn’t be more than 25% of your total pre-tax income, with another 5% for taxes, insurance and routine maintenance. Your car payment shouldn’t be more than 15% of after tax income, with another 5% for insurance and routine maintenance.
By then you’ve already used up half your income. Of the other half, try to set aside 20% for your retirement plan. Calculate your monthly expenses which include food, clothing, groceries and others. If you still have balance after deducting all the above expenses, use it for emergencies, if any, or put into a tax-deferred savings plan. If you don’t have that kind of discipline, at least restrict the amount you spend on non routine items to 10%, which will sharply increase your chances of staying out of ruinous debt in the future.
If you have done all your calculations and honestly found your debt still at a manageable level, go ahead and rush off to the mall before someone else beats you to your dream home theater equipment.
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