Thursday, February 7, 2013

Questions to ask yourself before taking on debt

With the economy seemingly on the upswing, many folks are becoming consumers again. Whether it's a bigger house, a newer car, an expensive vacation, or a roomful of electronics, many items will be financed with debt. But before you sign that loan document or credit application, take a few moments to consider the following questions:
  • Can I afford the payments? The housing crisis of the past few years resulted, in part, from defaults on home mortgages. Homebuyers were sold on the idea that they should borrow up to the limit of their available credit. Unfortunately, when housing prices declined and layoffs began, huge house payments drained the resources of many mortgage holders. Folks learned about debt the hard way. As a rule of thumb, your house payment (including taxes and insurance) shouldn't exceed 30% of your gross income. Remember, too, that most credit cards have variable rates. When (not if) interest rates start climbing, credit card debt is likely to become more expensive. So think twice before using that convenient plastic to pay for a new dining room set or a trip to Fiji.
  • Is the loan secured? In other words, does the lender require some form of collateral for the loan? With a mortgage, that security is real estate. With an auto loan, your car is on the line. If you don't make the required payments, lenders have every right to take your house or car. On the other hand, secured loans tend to have lower interest rates because lenders consider them less risky. So, again, take a long hard look at whether you can afford the payments, month in and month out. If in doubt, reconsider your options.
  • How close am I to retirement? If you have to reduce or forego your regular retirement saving to buy some shiny new item, slow down. Consider alternatives. Instead of purchasing a new luxury car, you may want to refurbish the vehicle that's sitting in your driveway. These days, many people can expect to live 30 years or more after retiring from full-time employment. That's a long time and a lot of expenses. Unless you expect your income to increase in retirement, adding loan payments may squeeze an already tight budget.
Finally, ask yourself, "Do I really need this now?" Saving for purchases may be old fashioned, but it's often the wisest choice.
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