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Reducing your debt is manageable

Personal Finances column
By: Paul Apfel Inside Lincoln columnist
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With international, national and state government debt issues much in the news, Lincoln consumers should be taking a close look at their own debt environment to see where they stand. Equally important in that assessment are considerations regarding where they are today and where they’ll be in the near future. Humorist Will Rogers is credited with noting that if you find yourself in a hole, the first thing you do is stop digging. So are you in a hole? And do you have any prospects about getting out of that dilemma? Let’s look at some data that might help put all this in perspective. According to the Federal Reserve Bank of New York, total consumer debt as of the third quarter of 2010 was $11.6 trillion, with mortgage debt comprising 74 percent of that or $8.6 trillion. Credit cards, home equity lines of credit and car loans were each six percent of the total while student loans added five percent and the “other” category added the remaining three percent. CreditKarma.com, an Internet site that states it is a consumer’s credit advocate, released data last June that showed overall credit card and mortgage spending slowing from the previous year with the average credit card debt per consumer falling 15 percent to $6,470 and average mortgage debt declining two percent to $172, 957. California was one of eight states where consumers decreased their mortgage by three percent more than the national average. Credit scores fell three points nationally from May 2010, according to the same report, with California consumers holding the highest credit score among states at 685. So, according to some national statistics, Californians are holding their own in this slowly emerging economy. But are we really healthy? And what consumer debt is appropriate and sustainable? Mortgage bankers typically look at ratios when considering a potential borrower’s credit-worthiness. The so-called back-end ratio, which is a total debt-to-income ratio, consists of your total monthly long-term debt payments, including mortgage and credit cards, child support, alimony, car and college loans and should not exceed 36 percent of your gross monthly income. The housing expense ratio, sometimes called the front-end ratio, is calculated on the basis of your gross (pre-tax) income that would pay your monthly housing expense of principal, interest, taxes and insurance. This ratio should be no more than 28 percent. While real estate financing professionals may rely on the ratios to grant housing loans, consumers can also use them as a rule of thumb in determining their relative financial health. Most financial experts would agree that 36 percent or less is a healthy debt load for most individuals. At 37 to 42 percent, the ratio is not bad but consumers should take steps to pare down debt before getting into real trouble. Ratchet the ratio to the range of 43 to 49 percent and trouble looms unless you take immediate action. And debt levels above 50 percent call for aggressive measures to reduce debt. The U.S. is world-famous for its effective marketing and sales efforts designed to convince the American consumer that this or that product or service is indispensable. And the proliferation of credit cards makes it too easy to accommodate our merchants. But the savvy consumer will be cautious and mindful of his or her debt obligations. If you use a credit card, pay it off each month. Don’t carry a balance. But, if you did slip a bit in the past and you are currently carrying a credit card balance, design a payment plan to eliminate that as quickly as possible. And adjust your other spending accordingly.