New Year: Time to Get Your Financial House in Order

At the beginning of the New Year, resolutions are made for self-improvement. It’s time to get healthy and tighten the belt. And we mean tighten the belt in more ways than one. The New Year is also the time to get your financial house in order by managing your debt.

The debt conversation is one we have with every type of client: For the young adults who are taking on student loans for college, we warn about overborrowing to support a lifestyle. Likewise, we warn emptynesters who want to travel and see the world that it is often not the best use of money once the children are “off the payroll.”

When looking at personal debt, nearly everyone wants to know what the ideal debt-to-income ratio is. Evaluate what you have coming in, such as, your income, royalties or rents, dividends, and interest compared to your obligations, such as, your mortgage, loans, credit cards, student loans, car payments, etc. Divide your monthly obligations by what you have coming in each month. Generally, you want to be around 28% to 36%. Of course, to change that debt-to-income ratio, you must either lower your debt or increase your income.

You’ll often see mortgage lenders placing a lot of emphasis on your debt-to-income ratio when they are considering you for a loan. They generally like to see a debt-to-income around 28% when applying for a mortgage. But just because you can go up to 36% debt-to-income, doesn’t mean you should. Unfortunately, this practice often results in consumers being pre-approved for loans that are much more than they can actually afford on a monthly basis. Your debt-to-income may show that you can afford a $1,200 mortgage payment, but as most homeowners quickly learn, that is not the end of their housing costs. There are utilities, insurance, lawn maintenance, and repairs that come with a home. Nearly every homeowner has a “horror” story of having to replace a major appliance—a hot water heater and an HVAC unit—within three months of ownership!

We also see many investors with a “Depression” mentality—where all debt is bad, and they will do everything they can to never have debt. When it comes to credit cards, we would agree. Credit cards can charge up to 36% annual percentage rate on balances. However, we view mortgages as more of a grey area. In the past several years, you could have refinanced your home loan and have a mortgage at 3.75% annual percentage rate. Therefore, you have to wonder if it is smart to take money out of savings or the stock market to pay off a mortgage? In our opinion, not really. We believe an investor can still earn more in the stock market than they would save on interest by paying down the mortgage early.

Even if you can improve your debt-to-income ratio by making more money and spending less, you still need to pay down debt you have accrued. Luckily, there are several ways to do it. You can start by paying off the smallest balance first and then begin on the next smallest debt; therefore, you see the number of outstanding balances decreasing. Another method is to begin paying down the highest interest rate first to save as much on the interest payments as you can. The method that works best is the one that keeps you motivated to continue paying down your debt.
If you have questions regarding your debt-to-income ratio, the experts at Henssler Financial will be glad to help:

This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.

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