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The financial crisis of 2008-2009, along with more recent concern over the large debts run up by Greece and some other members of the European Union, has made debt a frequent topic of meetings with clients.
The financial crisis of 2008-2009, along with more recent concern over the large debts run up by Greece and some other members of the European Union, has made debt a frequent topic of meetings with our clients. Specifically, what should it be used for, and how much of it is too much?
What is reasonable debt? Historically, most banks have said that to qualify for a mortgage loan, your monthly mortgage payment, including taxes and insurance, could not exceed 28 percent of your monthly pre-tax income. In addition, your total monthly installment loan payments (mortgage payment, car loan, student loan, credit card, etc.) could not exceed 36 percent of monthly gross income.
A key point to consider is that qualifying for a loan is not the same as affording it. Over the past decade, some borrowers whose ratios were well over 60 percent still were receiving credit. You need to look carefully at your specific situation and make sure you can afford a loan given your other goals and obligations.
Our local, state, and federal governments also are facing a debt crisis. According to a report from the Pew Center on the States, state governments face a trillion-dollar gap between the pension, healthcare, and other retirement benefits promised to public employees and the amount contributed to fund those obligations.
But even those shortfalls are insignificant compared with the federal debt, currently more than $13 trillion. And that figure does not include unfunded liabilities and promises made for funding Social Security, Medicare, and Medicaid, which total additional tens of trillions of dollars.
The state and federal debts are going to require most individuals to shoulder more of the burden for their healthcare and retirement in the future. This funding probably will be accomplished through longer waits before collecting Social Security benefits while contributing more into the system (higher taxes). Taxes are already scheduled to increase in 2011, with top federal rates going from 35 percent to 39.6 percent. You should begin planning for these additional costs now.
BORROW LESS, INVEST MORE
Looking ahead, we are advising clients to take on less debt and to make paying down existing debt a major priority, along with investing for the future. Often, people focus too much on the daily gyrations of the stock markets while paying too little attention to their debt levels and to ensuring that they have adequate savings for a drop in income, higher taxes, or unexpected expenses.
We believe that Americans will continue to enjoy one of the world's highest standards of living. We also believe, however, that it is prudent to be more conservative in retirement projections and that people will need to be more aggressive in their budgeting and savings goals.
The key to success is making sure you are not overextended in your daily living and that you have a cushion. Through balance and delayed gratification, you can weather life's financial storms.
The author is a fee-only certified financial planner with Preston & Cleveland Wealth Management LLC (http://www.preston-cleveland.com) in Atlanta and Augusta, Georgia, and a member of the National Association of Personal Financial Advisors. The ideas expressed in this column are his alone and do not represent the views of Medical Economics. If you have a comment or a topic you would like to see covered here, please email firstname.lastname@example.org