8 Rules For Smart Borrowing

Even people who are financially well off can be at risk of slipping into debt, especially in a staggering economy. There are plenty of doctors, lawyers and stock brokers who are currently on debt-management plans, according to David Jones, president of the Association of Independent Consumer Credit Counseling Agencies. Some of the warning signs of excess debt include: relying on home-equity credit lines or credit cards for everyday purchases, making only minimum payments on extended lines of credit and taking cash advances from one source of credit to pay another. To help save you from a downward-spiral into debt, Consumer Reports has put together a handy list of rules for smart borrowing. Here’s one of our favorites…

36%-48%
Ideally, your total monthly debt payments shouldn’t exceed 36 percent of your gross monthly income. But, Jones says, many people go above 48 percent, which should be avoided if possible.

In a perfect world debt payments wouldn’t exceed 0% of our monthly incomes. Since our world is far from perfect, check out the rest of the rules here.

Your debt, 8 benchmarks for borrowing [Consumer Reports]
(Photo: Getty)

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  1. RBecho says:

    Some all in all good advice. One of the keys in there was having 6 months worth of expenses in CASH on hand (bank account) and not to count on credit cards for this.

    The important thing there is to not get into debt should you have an employment issue, or sudden expenses (medical emergency).

  2. mike says:

    @RBecho: 6 months of expenses in cash is a smart thing, but not always possible for people.

    Put as much money away as possible (6 months is a great goal), but having a high-limit, low interest credit card available for emergancies while saving can be smart. If you’re worried about using it, one tip I picked up is putting the credit card in a metal tin (Altoids tins work well for this), put the credit card in some water, and then put in the freezer. When you need it, put the tin in boiling water to retrieve the card.

  3. @RBecho: I’m a bit of a contrarian on the “6 months” thing, for those who have good credit and solid work history. I usually stick with 3-4 months and be sure to have a lot of unused credit available. That way, I can use my resources in a two-tiered system depending on how dire the circumstances.

    I just don’t like tying up lots of cash in very liquid form when it can be used for retirement investments, etc (which could also be liquidated in times of financial hardship). YMMV depending on working spouse, number of kids, etc.

  4. teapartys_over says:

    Not all debt is bad, eg. student loans and mortgage debt (if you have a good fixed rate). So I don’t agree about the 0% “ideal”.

  5. mac-phisto says:

    In a perfect world debt payments shouldn’t exceed 0% of your monthly income.

    i can’t agree with that statement. if the cost of an opportunity missed by not going into debt exceeds the cost of the debt itself, then one is doing themselves a great injustice by avoiding debt altogether, no?

    education would be the most visible argument in favor of debt in the pursuit of greater wealth in the long-term.

  6. mac-phisto says:

    don’t mind me…cleaning up a missed tag

  7. ratnerstar says:

    Your monthly mortgage payment (including property taxes and insurance) shouldn’t exceed 28 percent of your gross monthly income.

    This is repeated everywhere (I confess I used it as a rule of thumb when getting my home loan), but the more I think about it the less sense it makes. Why is your gross income the standard? My mortgage payment is well below 28% of my gross income, but just about half of my net monthly take home pay (after taxes, 401k, health insurance, etc). Since net income can vary so much between people, shouldn’t it be the yardstick?

    Can anyone fill me in on this?

  8. failurate says:

    @teapartys_over: How is student loan debt and mortgage debt better than $0.00 debt?

    At 0% debt, you don’t have to worry about tax deductions cause you didn’t have to pay out the interest in the first place.

  9. Fist-o™ says:

    @linus: I personally believe that it is possible for almost everybody to acquire six months of emergency money. I didn’t think I could ever do it, especially after getting married and having a child, but we did it anyway. Exceptions may be the elderly, the disabled, or single unskilled parents of many children. Or students. In their case, other options may be available.

    If not, then they are living beyond their means and need to re-assess their spending.

    I know the feeling of security that a CC can give. I experienced a moment of butterfly stomach as I cancelled my last credit card (Outlined in a previous post). I considered that to be a psychological attachment to the feeling of security it gave me, and it made me mad that I felt this dependence on a CC. They don’t care about you. They care about making a profit.

  10. humphrmi says:

    @teapartys_over: Agreed, in fact I’d take it a step further and say that financially smart people see cheap credit as a boon right now. If you qualify, you can borrow dollars cheap now, and the lender really takes it on the chin because as inflation rises the dollars you repay are worth less than the dollars you borrowed.

    In other words, taking credit now, while it’s cheap, effectively gives you a “hedge” against inflation.

    But of course it’s all predicated on the notion that a borrower can responsibly manage their credit.

  11. Fist-o™ says:

    @teapartys_over: STUDENT LOAN DEBT IS NOT BAD? I must respectfully disagree. Non-Bankruptable; the only type of debt that they can garnish your wages WITHOUT a court order, usually upwards of $20,000 and higher, interest rates higher than my MORTGAGE…

    When I kick Sallie Mae out, I will finally be debt free, and I’m going to write a song about it, I’ll be so happy.

  12. Fist-o™ says:

    @humphrmi: Could this cause a “Credit Crunch” in the future, similar to the current “Mortgage Crisis”?

  13. humphrmi says:

    @Fist-o: It may be possible, but is it financially smart?

    I put all my spare income into retirement accounts, except a very small (~$200 / Mo) cash savings I allow myself. At that rate, it will take me years to save six months cash.

    Sure I could stop making 401(k) or Roth IRA contributions, But what about the lost growth? I would rather take the risk that I need to liquidate part of my 401(k) (after all my other savings is depleted… and I do have a *few* months worth of liquid cash saved…) against missing the growth opportunity that will support me for many years, rather than six months, in my retirement.

  14. humphrmi says:

    @Fist-o: Sure, it could, but again, only if borrowers don’t responibly manage their money.

  15. smythe says:

    @failurate: If you dont go to college in order to stay at 0% debt. Or if you simply dont buy a house because you don’t want to go into debt. Sometime debt is necissary, but only when the gain exceeds the cost.

    The $600 I spend monthly on mortgage interest is much cheaper than I would pay to rent my house, and that amount will go down over time as I pay off my mortgage making it an even better deal. Plus I get to write it all off at the end of the year, something you can’t do with rent.

  16. johnva says:

    @failurate: It can be better to have debt than not to have debt because there is an opportunity cost to not having debt. That is, you are giving up the opportunity to do something else with the money that you are using to pay down debt. For example, look at mortgage debt. You can pay it down early if you have the money available, and this will certainly save you from paying as much interest in the long run. Or, you can take that money and invest it somewhere else. If that investment generates returns at a higher rate than the interest rate on your mortgage, then it’s better to invest. In other words, the leverage the mortgage provides you allows you to make MORE money than if you didn’t have any debt.

    Of course, there are a lot of variables there. For example, must you take a substantial risk with your money to beat the interest rate on your mortgage? Are you taking too much of a risk to keep a mortgage on your house if there is a down market (generally no, in this scenario, since you now also have a pile of cash from the alternative investments that you could use to pay down your mortgage at any time).

  17. MeOhMy says:

    @failurate:

    @teapartys_over: How is student loan debt and mortgage debt better than $0.00 debt?

    If you can get a house and an education without taking on any debt, sure.
    If it’s a tradeoff between no house/no education and no debt, then taking on the debt is a better proposition. In some cases even if you DID have the cash, taking on the debt is STILL a better proposition. You have to crunch numbers to figure out when taking on debt is better than not doing so, but simply having a “No debt at all” mantra is actually not a great financial strategy. No “Consumer Debt” at all…that’s a better mantra.

  18. johnva says:

    @Troy F.: Exactly.

    Part of the difference of opinion on this, I think, is risk tolerance. Why do people think that hedge funds and such take on debt? It’s simple…it’s because it can magnify their gains (just like mortgage debt can magnify people’s gains and losses on real estate). It’s leverage.

  19. celticgina says:

    Wait! David Jones LEFT the Monkees to work at Debt Counseling?

  20. TWinter says:

    Lots of people get in trouble because of simplistic categorization of student and home loans as “good debt”. It is good if you use it wisely, but not every student loan and not every home loan is good.

    Borrowing as little as you can get by with to go to a state school or a really well respected private school is good.

    Borrowing the max possible to go to an obscure private school to major is something very esoteric and hard to market is bad.

    Borrowing on a fixed rate loan to purchase a modest house in a reasonable housing market is good.

    Borrowing on an interest only ARM to buy an enormous house in an overinflated housing market is bad.

    Every situation has to be analyzed separately.

  21. Fist-o™ says:

    @humphrmi: Interesting. So in your case, you’ve leveraged risk against your retirement funds. (By that, I mean, you are risking that you won’t have an emergency, vs. the hit you’d take on your retirement funds to pay for it). I personally do not wish to take such a risk, so for me, the interest lost by NOT putting that money into retirement, but instead into the ING account, is worth it. I suppose it’s a question of risk, and how much one cares to take.

    I think it’s great you think about retirement; the catch-22 is that the younger you start, the better off you are; yet the young very rarely contribute into a Roth or 401k.

    In either case, though, I still disagree with Linus’ idea of keeping a credit card in the freezer for emergencies. My freezer is too jam packed with batteries, coffee, and all the other weird crap that you’re “Supposed” to store in the freezer! The article in question specifically outlined the guy who did such a thing, and got screwed.

  22. bonzombiekitty says:

    @teapartys_over: Agreed. Debt is what makes the world go ’round actually. Debt is something you should be entering in order to invest in yourself so you can make/produce more in the future than you do now and do it faster. I could save up $$$ to start a business debt free, but that would take years. Or I could go into debt and start a business now and in have a higher profit margin over the years I would have been saving up to start the business. However, the key is not to have TOO much debt or debt that is not appropriate (i.e. credit card debts due to spending a bunch of money on expensive, unnecessary clothes).

    As for the 6 months salary thing, I’m getting towards having that saved up, I’m at about 4.5 months. But I think that within the next two years that’ll be wiped out so I can buy a house. I hate renting but houses around here are way too expensive.

  23. johnva says:

    @TWinter: Yes, obviously a critical part of the analysis should be whether it actually makes sense to spend the money you’re spending on something. Is that education or house actually a good investment? Too many people skip that step. Simplistic maxims are always problematic if you don’t understand the underlying reasoning behind them.

  24. bonzombiekitty says:

    @Fist-o: Mhmmm. My friends and I seem to be the odd ones out. Most my friends I graduated with took retirement plans into consideration when looking for a job, the others are in grad school. I’m fortunate enough to work for a company that matches up to 10% of annual salary for our 401k, and our 401k plan itself is pretty good with a lot of options (even direct stock market trading if we really want to). So I’ve been contributing 10% of my salary since I’ve been able to contribute, which really makes it 20% of my salary. That makes me nice and ahead of the game when compared to many other people my age.

  25. ratnerstar says:

    @bonzombiekitty: ten percent?! Damn, you guys hiring?!

  26. johnva says:

    @Fist-o: There are a lot of reasons why young people today tend to contribute less to retirement plans than older people.

    * They make less money.
    * They have more student loan debt, since college is far more expensive now than it was when Boomers were young.
    * Fewer of them are even in jobs where they can get a 401(k), much less a matched one.
    * They have other financial needs that older people don’t, like saving for their first house.

    That being said, I do think that some of it is simple ignorance and lack of long-term planning. But some of it is also that younger people have been given a raw deal compared to previous generations in that wages aren’t increasing, education is so expensive, pension plans rarely exist anymore outside of a few large companies or government jobs, etc. Personally, that motivates me MORE to save more, since I know that no one else is going to be looking out for me. But I also think that the end result of this is going to be a lot of people with no retirement plan. This will probably result in political pressure and eventual government intervention.

  27. I definitely agree that prudent use of debt is a good thing.

    If businesses relied solely on organic growth, they’d be in constant cash crunches and capital expenditures would almost never occur. It typically takes companies many decades of success before they can self-finance, self-insure, etc.

    If you treat people the same way, then the comparison holds…but since consumers typically use debt to buy depreciating assets (toys), it’s more like a poorly-run company.

  28. bohemian says:

    @Fist-o: I have to agree. Student loan debt has to be the worst debt to have for exactly the reasons Fist-o stated. Even a crappy predatory credit card has some potential for some redress or relief if you get in a bad situation.

  29. mac-phisto says:

    @Fist-o: STUDENT LOAN DEBT IS NOT BAD? I must respectfully disagree.

    i must respectfully disagree with your disagreement. my student loan debt costs me $80/mo ($960/year) at 2.75%APR. over 10 years, that money costs me ~$1200 to borrow. i also contribute $320/mo into my 401(k) which is currently performing at ~8%.

    now, if i forgo the 401(k) contributions & accelerate my student loan payments, i could pay them off in 2 years & then contribute the full $400/mo into my 401(k) & save ~$1000 in interest payments.

    HOWEVER, i will have lost approximately $5000 in interest (assuming a constant 8% return on investment). even though the contributions are the same ($320*120mo = $400*96mo = $38400), the amount at the end of that 10 years is very different ($58,542.00 vs. $53,547.00).

    so there you go…there’s my personal example of why debt is GOOD (sometimes).

  30. @teapartys_over:

    Not all debt is bad, eg. student loans and mortgage debt (if you have a good fixed rate). So I don’t agree about the 0% “ideal”.

    There’s no good debt – only debt that isn’t as bad.

    Student Loan debt is at a low rate, but you’re paying interest – that’s not “good”.

    A house is an asset that typically appreciates, but you’re paying radical amounts of interest over the history of the loan – that’s not “good”.

  31. johnva says:

    @bohemian: Yes, student loan lenders have gotten rather predatory and their lobbyists have rewritten the laws in their favor with the compliance of a Republican Congress and president. I do think that some of those things should be reformed to restore some basic consumer protections to student loans, especially private ones. But the solution is not to just not go to college if you can’t afford it outright. The solution is to elect people that will not write horrible anti-consumer lending laws.

  32. Erwos says:

    @johnva: Any reasonable savings plan should factor in the massive tax increases that we’ll see when the government finally realizes that they can’t fund social security anymore. Smart people invest in both their 401ks AND their IRAs.

  33. ratnerstar says:

    For all the people saying there’s no relief from student loan debt: try joining the Army. When I joined, back in 2001, they would pay them off up to $60,000; that number has most likely increased. Also, enlisting in the military doesn’t ruin your credit rating.

  34. johnva says:

    @InfiniTrent: Wrong. Some debt allows you to make more money than if you didn’t have debt at all. That’s the whole idea behind business loans. Read and understand this article: Leverage

  35. johnva says:

    @Erwos: Oh, I agree. You should do whatever you can to save as much as possible for retirement in tax-advantaged accounts. I think the most likely outcome on Social Security is going to be a combination of tax increases and benefit cuts, BTW. The benefit cuts will be camouflaged so that they aren’t so obvious to people.

  36. mac-phisto says:

    @johnva: really? i’m under the impression that one day they’ll just stop the printing presses, shutter the office doors, dead circuit the phone lines, 404 the website & pretend like it never existed.

    “what is this social security you speak of?”

  37. MeOhMy says:

    @johnva: I guess it’s wishful thinking that when the well runs dry that clusterf*** would just be abandoned :-(

  38. spinachdip says:

    @bohemian: Are you kidding?

    Well, I guess it depends on who you borrow from, but all my student loan debt is federal, and the interest is low, and I can get deferral for any reason. Have you ever tried telling a bank that you won’t be making your payments on a loan or credit card balance for the next six months?

    It’s an investment, and sure, there are always bad investments. But is the loan likely to pay for itself through higher paying jobs? What is the opportunity cost of waiting to go to school until you have saved enough? Would your course work be affected if you try to balance it with a full-time job? More likely than not, I say it’s an investment worth making.

  39. @humphrmi: “I put all my spare income into retirement accounts, except a very small (~$200 / Mo) cash savings I allow myself. At that rate, it will take me years to save six months cash.”

    Yes, this is also my concern. I *could* get to six months, but I can also be using that to fund my retirement account, pay down my mortgage to get the PMI taken off, pay down student loans (got rid of the variable rate ones, yay!), etc. Right now I’m at about 3 months in dedicated emergency savings (plus some other cash in “saving for car for when car breaks down” and “general savings” and “house needs fixin'” kinds of savings, which maybe adds up to six months sometimes, but not other times), and I’m not sure how hard I want to work to increase that.

    I also come from a large, close-knit extended family, and the assumption is that in money crises, the extended family is a unit. I would expect in a catastrophe that relatives would make zero-interest loans available or other help as we needed it and they could afford it. Similarly, I’d make that help available to them. With that “private” safety net available, I’m not sure six months is an advisable goal when I also need to save for retirement.

    OTOH, the psychological freedom that’ll come from knowing I have six months in reserve is probably worth it to me; I’ll probably get there eventually!

  40. Fist-o™ says:

    @mac-phisto: That goes to show that every situation is different.

    My student loans are at 7.625%. AFTER Consolidation.

  41. spinachdip says:

    @Erwos: All things considered, social security isn’t in that bad a shape, at least compared to other federal programs (we should be more afraid of what baby boomer retirees will do to Medicare).

    I do agree with your overall point – tax increases are inevitable (plus, social security was always meant to be a safety net, not a nest egg – though I do like to see the Feds set up some sort of sovereign wealth fund type thing and reinvest the SS funds).

  42. Fist-o™ says:

    And just to make you all jealous… I’ve worked for a state institution, who, for the past 5 years, has contributed 12% of my income without me having to match it, into a 403b.

    Of course, state institutions typically pay less than industry, so… I guess really they’re just forcing me to invest 12% of my income into retirement. But I would do at least that anyway, so, I have no problem with it.

  43. johnva says:

    @mac-phisto: @Troy F.:

    Well, Social Security can’t go totally bankrupt as long as the SS payroll tax exists. They will always be able to pay out what they’re currently taking in, which is something like 78% of projected benefits they will owe or something like that if I recall correctly. The problem comes in when the tax revenue is no longer sufficient to pay for all the people who are retired. The solution is that they can raise taxes or cut the benefits, or both. But I think without a change in the law, the “default” will be that they simply won’t pay out all the benefits promised if there is a shortfall. This demographic shortfall was supposed to be covered by the “trust fund”, which is money the general treasury owes to Social Security. That money also legally has to be paid back, but the only way that can happen is if either income taxes are raised or spending is cut somewhere. In other words, the SS Trust Fund was spent on stuff like the wars in Iraq and defense spending.

    Remember, SS exists for a good reason. The reason was that in a time of economic collapse (the Great Depression), too many retirees were totally screwed and couldn’t even feed themselves. I think a social safety net is a good thing for this reason. Whether the current form of SS is the best way we could that is debatable. It would certainly be cheaper to (for example) make SS more like welfare and pay it only when people are truly in poverty. The problem with that is that the program’s longterm political support rests partly on the fact that it benefits everyone directly. And that might also discourage people from saving on their own.

  44. xthexlanternx says:

    I don’t understand how I’m supposed to stay below 48% when my student loan payment alone is 40%.

  45. xthexlanternx says:

    @mac-phisto:

    Can you please enlighten me on how to get a 2.75% student loan… mine are all upwards of 6% with one of them around 7.75%

  46. TheWraithL98 says:

    those percentages are completely out of reach for a household not making a 6 figure income. maybe with 2 incomes, but even that is skewed, since you would need two reliable vehicles.

    First off – car loan:

    so your non-mortgage monthly debts should be 20%, or less, of your income, but you shouldn’t ever take out more than a 3 year loan on a car.

    so for a person making $50,000 a year, they would probably net around 2900 a month, and 20% of that is $583.

    but if you finance $20,000 on a car loan, which is about as cheap as cars get, if you get a 36 month loan at a respectable 6% interest, you’re looking at $608 a month right there.

    $50,000 a year isn’t peanuts, and to maintain what is most likely a professional job, a reliable car is part of the deal. There is no way you can keep that payment anywhere close to reasonable based on the 20% rule on a 36 month loan.

    And then mortage debts – you shouldn’t spend more than 28% of your income on your mortgage. for that $50,000 a year person, that would leave a hair over $800 a month for mortgage – counting insurance and taxes. That might get you a $90,000 house. And what does $90,000 buy in a house?

  47. bonzombiekitty says:

    @xthexlanternx: Mine is at about 7%, all with AES. The only way consolidating lowers my monthly payments is if I extend the term of the loan to 20 years.

    *looks at loan balance*

    ughhhh. I feel like I’m not making any progress on that thing. I can’t wait until 2016 and I can pay the darn thing off. That’s a big chunk of my expense.

  48. Erwos says:

    @TheWraithL98: I totally disagree.

    You can get a car for well under $20k. Just buy a used car. Our monthly car payments were only $350-$375, and that was only over 36 months.

    And the answer is, no, you can’t afford a house. Save up a bigger down payment, and rent in the meantime.

  49. Here’s my problem with people investing in retirement accounts heavily BEFORE paying off consumer debt like Credit Cards, and other debt like Student Loans:

    Even if you make reasonable returns in your IRA or 401(k), say 10%, what good is that if your debt is accruing interest at 6-10% also? You’re offsetting your gains through the interest you’re paying.

    I’m contributing to my 401(k) only enough to maximize my company’s match, then throwing virtually all of my spare money at getting out of debt – once I’m out of debt, I can invest the interest I would have paid into my retirement or other investments.

    People, kill all your debt (maybe not the mortgage, since it has an asset offsetting the debt) THEN invest and save – you’ll have more money than you imagined.

  50. @TheWraithL98:

    but if you finance $20,000 on a car loan, which is about as cheap as cars get, if you get a 36 month loan at a respectable 6% interest, you’re looking at $608 a month right there.

    A $20,000 car is very nice, and you can buy a reliable vehicle for much less than that.

    We, as Americans, have decided we’re entitled to a new or nearly new car – we’re not. A car is one of the worst debts you can incur, and people constantly take on big car payments at the expense of their financial health.

    Buy a $10,000 car (a 2006 Hyundai Sonata, a 2003 Accord, etc.) and use the rest of the money wisely.

  51. MeOhMy says:

    @TheWraithL98:

    you shouldn’t ever take out more than a 3 year loan on a car.

    Not really…if the numbers make sense for your situation, take out a 5 year loan. And you can also make a larger down payment.

  52. @bonzombiekitty:

    Mine is at about 7%, all with AES. The only way consolidating lowers my monthly payments is if I extend the term of the loan to 20 years.

    *looks at loan balance*

    ughhhh. I feel like I’m not making any progress on that thing. I can’t wait until 2016 and I can pay the darn thing off. That’s a big chunk of my expense.

    Why not consolidate, extend the term to 20 years, then just pay extra each month? Are there early-pay penalties under the consolidation program you’re looking at?

  53. Orv says:

    @johnva: For example, look at mortgage debt. You can pay it down early if you have the money available, and this will certainly save you from paying as much interest in the long run. Or, you can take that money and invest it somewhere else. If that investment generates returns at a higher rate than the interest rate on your mortgage, then it’s better to invest.

    This is a form of leverage — you’re effectively borrowing against your house and investing it in the hopes the return will outpace the debt interest. You’re right that there’s a reasonable chance the math will work out, but you’re still taking a larger risk here than if you paid down the debt first.

  54. mac-phisto says:

    @xthexlanternx: luck of the draw, i guess. i refinanced with AES in 2002 (i think) & shortly thereafter i believe they changed the rules w/ regards to what index student loan interest rates were pegged against.

    initially, it was 3.5%, but they reduced it with autopay & so many consecutive payments (36 months, i believe).

    one downside is that i had to pick a repayment term of 10 or 15 years & whether i pay it off in 2 years or 15, i believe i pay the same amount of interest (so to be honest, my “interest saved” calculation above may be false).

  55. xthexlanternx says:

    @InfiniTrent:

    I agree on the new car thing. No one in my immediate family has ever bought a new car. We get them two years old after someone’s lease is up for much cheaper and they’re still in great condition and under warranty. I will never understand why people buy new cars when they depreciate so fast (unless you’re super rich).

    One of my best friends just got married, they both have student loans, and he and his wife both have new cars (one an 06 and one an 08) which they are making payments on. Oh, and they both don’t even have jobs that are for a college grad. They just use their degrees to be a receptionist for a doctor’s office and a waiter at a very popular restaurant. I look around at others my age and I am very puzzled how people can ever think debt is a good idea. I hate debt and my student loans drive me nuts because I wish I could pay them off faster.

  56. johnva says:

    @InfiniTrent: Which is better (investing or paying down debt) depends entirely on the percentage return you get from each. If the debt interest is higher than the reasonable return you can get from investing (as is the case with credit cards, generally) you should pay down the debt. If the debt interest is lower, you should invest assuming you are willing to accept the risk. It’s quite simple in theory, but there are many possible complicating factors. But the math works out that it’s better to do whichever creates a higher return.

    @Orv: Actually, whether it’s higher risk or not only depends on the relative risk of the two options (investing vs. paying down your mortgage). There are risks associated with both, some of which people often don’t psychologically account for. For example, putting all of your money into your house has a liquidity risk, in that it may not be easy to get that money out in the future if you need it at some point. Stocks or bonds are much more liquid than real estate. Also, a properly balanced and risk-controlled investment portfolio may actually be safer than real estate at times. And sometimes even essentially risk free investments like CDs, savings accounts, and Treasury bonds may give you a better return than your mortgage interest rate if your mortgage is fixed rate at a very low interest rate (for a while earlier this year, some people with very good credit were getting fixed-rate mortgages for under 5% interest).

  57. battra92 says:

    @InfiniTrent: Buy a $10,000 car (a 2006 Hyundai Sonata, a 2003 Accord, etc.) and use the rest of the money wisely.

    I kick myself regularly for that $400 a month payment I make on my 07 Sonata when I could have bought a gently used one for a good chunk of change less. Still, I’m biting the bullet and plan to pay it off early and then I will keep it for at least 10 years or 150K miles. I love the car, just kinda wish I had let someone else do the depreciation.

    On the bright side of life I killed my first student loan last night! I feel so cleaned and my debt to income ratio is much better off now. :)

  58. @xthexlanternx: Invent a time machine, go back in time, consolidate in 2003/2004. I’m at 2.5%, husband’s at 2.25%, 30-year repayment period, fixed rates. (We just paid off the non-federally-subsidized, which were variable rate and so much, much, MUCH higher when interest rates were high; those we were paying off as fast as possible.)

    I pay extra towards them now and then, but for us it REALLY doesn’t make sense to pay off the student loans faster, since a simple savings account can get more than 2.5% interest!

  59. @battra92: “On the bright side of life I killed my first student loan last night! I feel so cleaned and my debt to income ratio is much better off now. :)”

    Isn’t that the BEST FEELING IN THE ENTIRE WORLD? I paid off our commercial loan and had my own private dance party. :D

  60. TheWraithL98 says:

    in regards to those who replied.

    first off – @ Troy F.. The quote about never taking more than a 3 year car loan was from the “8 rules” article linked.

    and in regards to those who replied saying that 20,000 is more than enough for a car, i didn’t mean to imply that it’s not possible to get a decent car for less, I was just trying to make the point that of the under $600 the article calls for you to have in non-mortgage debt assuming $50,000 income, you’re supposed to have your car payment and all over non debts included in that figure, but a $20,000 car would completely wipe out that number alone on a 36 month loan. Even if you managed to make due with a $10,000 car, you still have a whopping under $300 left per month for any other debts.

    And the “you can’t afford a house, save up for a bigger down payment”, doesn’t rent money count toward non mortgage expenses? so much for having a car at all ;)

  61. Orv says:

    @TheWraithL98: There’s nothing wrong with your math, and there’s nothing wrong with the rules. What you’re seeing is just how squeezed the middle class has gotten.

  62. cerbie says:

    One of my best friends just got married, they both have student loans, and he and his wife both have new cars (one an 06 and one an 08) which they are making payments on.

    @xthexlanternx: agreed. New, shiny, with payments for years. My own mother was trying to nudge me to get a new car (the same mother that puts water in a jelly jar to help loosen up the last bits). I’ve had it bad, but when I crunch the numbers, the old ones still work out pretty good.
     
    Now, I’ve bought three cars, wrecked one, got suckered on one, and now am driving the third…the total costs, including insurance, has just edged to about $8,000. Ugh…but I didn’t get into a single-car first-embarrassing-wreck with a new 15-20k car, which would have left me with the loan payments and searching for another, and practically unpayable medical bills (anything and anyone close is out of network, of course). I got into it with a $1900 (up to that point) 17 year old car. By the time my current daily car reaches $5,000 (basically two more months), it’ll be cheap and easy to keep going. Still, no debt from it.
     
    I have no student loans or anything of the sort, and I would be way over my head, right now, if I did.
     
    Seems to me that the concept of, “good debt,” relies on a net increase in economic status over time. Even then, it’s rarely the person in debt who benefits from it; they just have to choose it as a lesser evil. It’s always a game, and even if you come out well, the house comes out better.
     
    What happens if your friend gets fired for some silly thing at the restaurant? Without some safety net, a couple of months could be disastrous.
     
    @InfiniTrent: Better yet, get a $0.5k-5k car, and use the rest wisely.
     
    Given all the new cars I see around, the credit problems are far from over (just moving markets), and we need a major collective shift in how we think about our finances, as a nation. The fruit of the “greatest generation” is ripening before us. We’ve got multiple generations that didn’t have to learn the financial values of their parents, and those of that see it are often having to learn by making the dumb mistakes ourselves.

  63. mac-phisto says:

    @TheWraithL98: one thing about your caclulations – i noticed they are based on NET income. i believe the article is based on GROSS income. with that in mind, you’d have roughly $840/mo. for a car payment & other non-mortgage debt & roughly $1175 for a mortgage payment.

    now, assuming a 20% down payment, that means you should be able to afford a $200,000 home (30yr fixed @ 6%), however many financial sources say that a good peg for what you can afford house-wise is 3x your gross income (or in this case, $150,000). using my same calculation (20% down, $120,00 financed for 30yr fixed @ 6%), your monthly payment would be less than $800 (or 19% of your gross).

  64. JiminyChristmas says:

    Speaking of “doctors, lawyers, and stockbrokers” being in bad financial shape I have to relate a story from years gone by when I worked retail. I worked in a picture framing shop and a couple came in and placed an order for work that totaled about $400. Their credit card was declined.

    They get on the phone with the CC company and in the course of their conversation I hear that their card, with a $20,000 limit, was maxed out and they were requesting a limit increase. Especially considering that I was making about $6.75/hr at the time, I was totally dumbfounded. Of course, who knows, maybe they were rolling in dough, paid off the $20K every month, and just couldn’t get their credit limits increased fast enough to enjoy their massive wealth. But I doubt it.

    OTOH, all that said, an MD or JD isn’t a straight ticket to wealth. Take a doc or lawyer with the typical amount of professional school loans, imagine they go into family practice or public interest law, and yeah, they are going to be living paycheck to paycheck.

  65. dragonvpm says:

    @TheWraithL98: I liked how you put that. IMO it makes more sense to get a 60 month car loan and plan to pay it off in 36 months (or 24 or whatever you can do) and give yourself the option to make the minimum payment if there should ever be a financial problem.

    Getting a 36 month loan just means that you never get any wiggle room if something should happen.

  66. battra92 says:

    @TheWraithL98: so for a person making $50,000 a year, they would probably net around 2900 a month, and 20% of that is $583.

    Why do you need that much car? I have a professional IT job and so long as your butt is at work, no one cares if you drive a Porsche or a Yugo.

  67. JiminyChristmas says:

    @InfiniTrent: Even if you make reasonable returns in your IRA or 401(k), say 10%, what good is that if your debt is accruing interest at 6-10% also? You’re offsetting your gains through the interest you’re paying.

    You would need to be paying some pretty heinous interest rates for debt repayment to make more sense than putting money in a tax-advantaged retirement account like an IRA or 401(k).

    Start with the taxes: I can put $1 pre-tax in a 401(k). That same dollar, after taxes, buys me maybe 75 cents in debt repayment. Alternatively, I can put an after-tax dollar in an IRA and the tax deduction still leaves me in better shape than using that money to pay debt.

    If you have an employer match to your 401(k), early debt repayment makes even less sense. Considering tax deferral + employer match + 8% historical average rate of return…as long as the cash flow worked out I wouldn’t even consider early debt repayment unless the rates were over 15% APR.

    Now, if you’re talking about putting money in a brokerage account that’s altogether different.

  68. @battra92:

    On the bright side of life I killed my first student loan last night! I feel so cleaned and my debt to income ratio is much better off now. :)

    Congratulations! My wife and I had three total, and we paid off the smallest, highest interest one about a month ago. It felt great to throw that lump sum at it and deprive Sallie Mae of all the interest!

  69. @JiminyChristmas:

    If you have an employer match to your 401(k), early debt repayment makes even less sense. Considering tax deferral + employer match + 8% historical average rate of return…as long as the cash flow worked out I wouldn’t even consider early debt repayment unless the rates were over 15% APR.

    Now, if you’re talking about putting money in a brokerage account that’s altogether different.

    You make a good point about tax advantaged funds vs. already taxed funds. I look at the compounding effect of a significant debt load (about $175,000 for me, counting the house) and want that gone ASAP, but I do contribute enough to my 401(k) to maximize my employer’s 40% match. I figure that 40% is just free money, so why not take it?

  70. dragonvpm says:

    On the whole, while those 8 points aren’t “bad,” it feels like they failed to provide a lot of detail an explain the logic behind those numbers (or maybe some of them are arbitrary). Several previous comments have highlighted the fact that a lot of the logic to manging finances is really about managing risk and I don’t really see that they’ve addressed that in the article.

    For instance, the 6 month savings rule seems completely arbitrary. Why not 5 months? Why not 7? A better (albeit harder to quantify) one might be “Find out the average amount of time someone in your field/area of expertise tends to be unemployed (e.g. 3-9 months) and plan accordingly” or perhaps, plan ahead for unexpected loss of work/income (e.g. have a triage plan of what expenses you could ditch and in what order you’d want to and be ready to execute it if necessary).

    @cerbie: Debt in and of itself isn’t a terrible thing. One (admittedly trivial) example that comes to mind off the top of my head is the ever popular no-interest/no-payment financing that random stores tend to offer. Even if you had 100% of the purchase price for something, assuming you exercise due diligence and you only buy something that is competitively priced, you can easily make money by investing that money in an X month CD so that it matures before your financing is due. Right there you would have had the use of someone else’s money while your money was quantifiably earning you interest.

    What’s even better you’d be enjoying the benefits of whatever it was you had bought and at the end of that you would be better off than if you had just paid cash for your item.

    Debt isn’t a bad thing… Coasting through life making assumptions about it (for better or worse) is a very bad thing and it’s something way too many people seem to do out of habit.

  71. Erwos says:

    @dragonvpm: It’s because, frankly, six months is enough for any non-self-employed profession. Otherwise, you’d just get the hopeless optimists deceiving themselves they’ll never be unemployed for more than a month.

  72. battra92 says:

    @InfiniTrent: @Eyebrows McGee:

    Thanks! :) The guys at work told me to celebrate and buy myself something special. Still, I do have that other lower interest one I locked in before I graduated but it’s nice to know my last year of college is clean and paid for. So now I have a race as to which will be paid off first: Car or Student loan. I’m betting on the car as that was the second highest interest after the loan I just paid off.

    The awesomest part is that I can start my 401K at work in August so it will be like I will never “miss” the money.

    Either way, it’s nice to have one monkey off my back. Just two more …

  73. cerbie says:

    @dragonvpm: Point taken, and that’s a pretty good black and white example. In that case, however, you are not making a choice between, “not having it right now,” “choosing something more affordable,” and, “going into debt to pay for it.”

    My point was much more that saying, “debt X is a good debt, and debt Y is a bad debt,” and even “%Z of this debt of your gross is good, %A is bad,” rely on your consistently gaining money relative to your need to pay, to keep up with historically rising costs. Now, it’s flat or shrinking for most folks, and many of the costs not factored in are making the rules of thumb not work that well.

    Taking those kinds of points as what you need to worry about bypasses the reasons for having them, and what your real concerns should be (long term physical and financial health).

    If your car, house, and CC bills are 60% of your gross monthly, but you can save a little, pay for everything you need, and do some retirement investing, you are going to be far better off than a person for whom it’s only 25%, but who has had to go to ramen noodles and oatmeal due rising costs of everything (hyperbole, I know), or maybe increase that CC debt.

    What is needed is a, “Look at how much is coming in, how much is taxed, how much is used for the various parts of your work, how much for personal needs, how much for personal wants, and how much needs to be paid out for how long,” kind of article, in something widely recognized, like CR, going over the importance of analyzing and planning (even though Murphy is always watching :)), rather than, “if you meet these benchmarks, here’s how to find a debt counselor.”

    Teaching as shallow as that CR article will not discourage the many folks, like xthexlanternx’s friend, that are likely harming themselves in the long run. They could be driving a crapmobile and paying down the student loans, or driving the crapmobile and saving up, or driving a crapmobile and enjoying themselves a bit more (well, when not in the crapmobile :)), or a nice mix. Then, later on, they could get something nicer, being in better shape to do so, thanks to not being held back by that extra few hundred per month.

    P.S. I used, “that,” and, “points,” far too much in this comment…

  74. Orv says:

    @Erwos: I’d argue that six months of *expenses* might be more reasonable than six months of wages…of course, for many people the two are the same, but they don’t have to be. I know if I lost my job my first order of business would be calling around and canceling the cable, the Netflix subscription, etc.