Understanding Debt: Unraveling the Maze of Financial Responsibilities
Debt is a financial obligation that many of us carry, and it comes in various forms. Two of the most common types of debt are credit card debt and mortgages, which many individuals manage regularly. However, it’s important to recognize that there are other kinds of debt as well, such as medical bills, school loans, and auto loans. These financial commitments can impact our lives in different ways, and understanding how to manage them effectively is crucial. In this section, we’ll delve into these different types of debt and provide valuable tips to help you navigate them with confidence.
Learning the Lingo: Why Knowing the Language of Debt Matters
When it comes to dealing with debt, it’s not just about making payments and keeping your finances in order. Understanding the terminology and language used in the world of debt is equally important. Why? Because this financial lingo helps you make informed decisions, avoid costly mistakes, and navigate the complexities of borrowing and repayment with confidence. Imagine you’re embarking on a journey to a new place. Without knowing the language spoken there, you might find it challenging to communicate, understand directions, or make the most of your experience. Similarly, in the world of debt, the terms and jargon used can often seem like a foreign language. By taking the time to learn this financial vocabulary, you equip yourself with a powerful tool to negotiate favorable terms, decipher contracts, and, most importantly, make choices that align with your long-term financial goals. In this section, we’ll demystify the language of debt and show you why it’s crucial to become fluent in these financial terms.
Money You Owe. Debt can be things like your apartment rental payment, your mortgage payment, your credit card bill, or your childcare expenses. Debt is a way of leveraging the use of money now to pay later. Debt is what you listed as expenses on the cash flow worksheet.
The money you have. Credit is also a term used to define a contractual agreement where you get something of value now that you agree to pay at a later date. For example, a credit card. A credit card is used to borrow money to make a purchase now and pay at a later date.
- The cost of borrowing money, expressed as a percentage that is charged for using credit.
- Simple interest is calculated on the balance of the loan.
- Compound interest is calculated on the balance of the loan and the interest that accumulates on it every period.
- When you use a credit card to make a purchase, you are using your credit to borrow money and pay for the purchase.
- If you pay for a portion or a minimum balance, you will also be charged an interest amount on your balance.
- Dive into the Summary of Credit Card Statement Image
- When you apply for a credit card, you are signing into a contract and agreeing to pay a defined interest rate on outstanding balances.
- The interest charged on your credit card is typically called APR; the Annual percentage rate.
- APR on credit card changes apply when a balance is carried from month to month.
- APR is calculated by using the daily rate multiplied by your daily card balance, which is then multiplied by the number of days in the billing cycle.
- What is most important is that this interest can add up quickly. The best advice is to pay off the credit card balances in full every month.
Debt to income ratio
Debt to income ratio is used to determine how much of a mortgage in which you will qualify. This means the maximum household expenses won’t exceed 28 percent of your gross monthly income AND your total household debt doesn’t exceed more than 36 percent of your gross monthly income.
- If you make $3,500 a month, your monthly mortgage should be no higher than $980, which would be 28 percent of your gross monthly income. (3500. X .28% = $980.)
- If you are applying for a mortgage with a partner the total income and expenses for both of you go into these calculations.
- When applying for a mortgage your credit score, payment history, income in any outstanding debts are evaluated to determine if you qualify for the proposed balance you need based on the cost of the home you want to purchase.
- 28/36 rule is one to follow this is also called your debt to income ratio to determine how much of a mortgage you can afford.
- According to the 28/36 rule, you or your household should spend no more than 28% of your gross monthly income on total housing costs. You should also avoid paying more than 36% of your gross monthly income toward any debt (including your mortgage payment).
- Your mortgage payment comprises more than just the principal amount you borrowed to purchase your home. It also incorporates interest charges. Furthermore, it may encompass an escrow account where a portion of your monthly payment is set aside for homeowners’ taxes and homeowners’ insurance.
- For instance, if your individual monthly income is $3,500, it’s generally recommended that your monthly mortgage payment should not exceed $980, which is approximately 28% of your gross monthly income. However, if you’re applying for a mortgage jointly with a partner, the total income and expenses for both of you are taken into account when making these calculations. This helps ensure that the mortgage you’re considering is well-suited to your combined financial situation.
- If you do not have a healthy credit score, it can impact the interest rate in the ability to qualify for a mortgage. A conventional loan requires a credit score of at least 620, but it’s ideal to have a score of 740 or above, which could allow you to make a lower down payment, get a more attractive interest rate and save on private mortgage insurance.
A Proven Method to Pay Down Debt.
The Snowball Method is a proven way to pay down debt. Let’s take a look at how the Snowball Method works.