Fear of accumulating debt is understandable. Many of us have it, especially those who have experienced first-hand how devastating and stressful paying a debt back can be.
I’m not a stranger to debt myself. I put myself through the wringer working part-time in addition to holding down a full-time job when I was fresh out of college. I had student loans, rent, and food expenses to think about, and my salary while working as a clerical assistant at an auditing firm was just enough to make ends meet. The healthy fear I had of being swamped in debt helped me keep my books straight.
Debt phobia can be good, but only to an extent. It keeps you from making rash financial decisions or borrowing money unless necessary. If it stops you from ever borrowing money, however, you’ll miss out on opportunities. You have to work on overcoming your fear.
Borrow Within Reason
There’s no reason to be scared of not being able to pay your debts if you borrow responsibly. All you need to do is avoid borrowing more than what you need and study the payment terms on your loan contract before you sign (which I discuss later in this article).
Borrowing within reason requires discipline and control over the urge to splurge on non-essentials. In 2016, CNBC reported that students use the excess of their student loans on non-educational expenses, like insurance, clothing, and gadgets. I wouldn’t say these expenses are all non-essentials, but it also would have been prudent to save the excess money and use it to start paying off the loan after graduation.
So, what is reasonable borrowing? I would say it would be borrowing for needs and wants, provided you can pay the monthly dues with enough left for savings, food, rent, and other essential expenses.
Understand Necessary Debts
Not all debts do a number on your credit score. When handled responsibly, debts can pull your score up.
I’m not saying you should borrow money to have a high credit score — that way leads to ruin. I encourage you to open a credit card account. As Forbes’ Nick Clements explained it so succinctly, your FICO score depends on three indicators:
- Timely payments
- Total debt
- How long you’ve had credit
The third factor depends on how early you start applying for credit. If you do well on all other factors, a long credit history can give you a high FICO score.
Other necessary debts you may have to make in your lifetime are college loans, business loans, and mortgage for your home. These loans pay off through education, employment, and security.
Understand Loan Terms
I believe every adult knows this, but a constant reminder doesn’t hurt: Take out a loan only if you can afford to pay it back every month. Most banks help you find out by calculating your debt-to-income (DTI) ratio. Personal finance experts recommend keeping your DTI at 36% or lower to avoid debt trouble.
This means if your monthly salary is $6,000, your debts should only amount to $2,160 per month (2,160 ÷ 6,000 = 36%).
Allow me to offer a tip: Instead of dividing your total debts per month by your gross monthly income, divide the sum by your net monthly income (gross monthly income minus taxes and other deductions). This formula gives you a higher DTI and keeps you well below the 36% mark.
Very few people have the privilege to live 100 percent debt-free. Borrowing money is inevitable, but you can take measures to avoid being in the red. Stick by the rules, be wise in spending money, and you won’t have to fear being in debt.
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