How Do I Get Better Credit?

As more and more Americans sink deeper and deeper into debt, our financial worries are only just beginning it seems.  We’re a nation of spenders, and it’s obvious by our big homes, fancy cars, and beastly credit cards bills.  Debt, it seems, is no longer a four-letter word.

And we’re not saying that debt is necessarily a bad thing.  Most people have to go into debt to buy things like a house or a car, and buying a house especially is an excellent investment.  But, how do you know when your debt is, well, too much?

Let’s start with a little “financial health” checklist.  Ask yourself these questions:

•  Do you have any savings?  If the answer is no, why not?

•  Do you consider your credit cards similar to a “savings account” and your credit line ample protection against emergencies?

•  How much credit card debt do you currently have?  Are you close to being maxed out?  Are you only making the minimum payments? 

•  Do you know how much you’re paying just in interest on your credit card debt?

•  Do you bounce checks?

•  Do you hide your spending habits from family and/friends?

 

These questions strike to the very heart of your financial situation right now, and it’s vital you know the answers.  If you don’t know how much credit card debt you have, then you need to gather your statements and add it all up.  Yes, it’s a scary thing to do and it’s probably why you haven’t done it yet.  But you can’t start making changes if you don’t know where you stand.

Now, to figure out if you’re in over your head we’re going to have to do some calculations and figure out what your debt to income ratio is.  This will tell how what percentage you’re using of your income to pay off your debts. 

The first thing you’re going to do is add up all your debts.  This includes your mortgage payment or rent, your car payment, the minimum you pay monthly on your credit cards, your monthly student loan payment, child support payments, and anything else you OWE.  Do not include things like utility bills or grocery bills, as these are not “loans” per say.  Here’s an example:

Mortgage: $1,000
Car: $300
Credit Card Payments: $100
Student Loan: $200

 

Added all up you’ve got $1,600 worth of debt each month.

Now you’re going to add up what you’re bringing in.  Include any bonuses you get (divide this number by 12) and any dividends you get from investments (again, divided by 12 if necessary).

For our example, we’ll pretend we’re bringing in $3,500 take home per month. 

Now, our debt-to-income ratio should be 36% or less.  That means that we should be spending 36% or less of our take-home income on paying off debts.  If you’re using more than that, you’ve got too much debt and are in over your head.

So, to figure out our debt-to-income ration we’re going to take our monthly debt payments and divide by our monthly income.  So:

$1,600 divided by $3,500 = .45 or 45%

We now know that bringing in $3,500 per month to cover $1,600 in debts is not healthy, because 45% is greater than 36%. 

Remember, your goal is to be spending less than 36% of your available income on paying debt. 

This is pretty much the same formula mortgage companies use to determine how much house you can afford. 

It’s hard to give statistics so you can measure how you stack up to your neighbors.  Financial analysts keep painting a grim picture on our financial health, bemoaning the fact that, for the first time ever, our country has a negative savings rate, and our average credit card debt is $8,000 or more.  Yes, the numbers are sobering, but you don’t have to be a statistic.

Your first goal should be to pay off your credit cards.  Make sure you know what your interest rates are, because this is really adding to your debt every single month.  If you’re paying debt on cards with 15% or 20% interest rates, then make it a priority to roll your balances off to a lower interest card and cancel your current ones.  This could save you hundreds each month just in interest.  Also, just paying your minimum balance each month is not good.  Strive to pay as much as you can, and at least try to double the minimum payment.  Otherwise you’ll never get them paid off.

Remember, although your situation may seem dispiriting, YOU have the power to change it.  Once you start taking action to get out of debt you’ll start feeling more empowered and confident that things will get better.  And the best piece of advice?  Stop using your credit cards!