The Great Recession forced many Americans to tighten their personal balance sheets. But six years later, a dark cloud of debt still looms large. Student loan debt has eclipsed $1.2 trillion. Credit card and revolving debt is off its highs but still rings in at nearly $900 billion. Americans have more than $3 trillion in outstanding debt, and that doesn’t include mortgages.
IN OVER YOUR HEAD? These numbers are mind-boggling, but they don’t really capture the essence of the trench warfare taking place in U.S. homes. For many, the battle rages on. Are you in the fight? Are prospective lenders knocking down your door or running for the hills at the sight of your application?
Here are three numbers you should examine for a clue as to whether you’re in too deep:
- Debt-to-income ratio Divide your monthly payments on all your debts (auto loans, mortgage, credit cards) by your monthly gross income. Anything below 36 percent is considered acceptable; anything over 40 percent is a warning shot across your financial bow.
- Credit score The “excellent” range for FICO scores starts at 750. But a good score alone is not enough to determine if things are OK. I’ve seen plenty of folks with a great score and a ton of debt. You could be headed for trouble if your score is trending down because of too much debt or late payments. Know your score, but look ahead.
- Retirement savings Too much debt can result in too little saving. A couple of years ago, Fidelity published its retirement-savings guidelines. The research concluded that an individual should have the equivalent of his or her salary saved for retirement by 35, three times that at 45, and five times at 55. While not necessarily retirement planning gospel, this approach could give you a usable benchmark. Are you feeling good now or rationalizing your numbers?
THE ROAD OUT If you’re beginning to think things in your financial world are not as they should be, let’s examine the path ahead:
- Budgeting Call it a spending plan, belt-tightening or whatever is necessary to get you to start tracking your income and expenses. The goal? Cut back and cut out to free up cash that can be applied to your existing debts. Spreadsheets, smartphone applications and other online tools linked to your bank accounts can aid the process.
Where to get help: On-installation personal financial-readiness classes and counselors, credit counseling services, personal finance classes, hourly fee-based financial planners
- Debt consolidation Combining all your debts into a single account can be an attractive option. Ideally, your newly consolidated account will have a low interest rate, or at least lower than your existing accounts. A couple of cautionary notes, though. First, for this to work you’ve got to address the root cause of your debt. If your debt is a byproduct of spending more than you earn and you don’t fix your excessive spending, you’ll end up with a big loan and a bunch of other debts. Second, if you end up using a secured loan – like a home equity loan – to consolidate unsecured debt, you’re putting the roof over your head at risk.
Where to get help: Your bank or credit union, mortgage lenders, a credit counseling service’s debt-management plan
- Negotiation This could mean talking to your existing creditors and trying to persuade them to lower the interest rate on your debt. Less interest means more of your payment goes toward your debt. It could also mean offering to pay less than you owe to knock out the debt. While asking for an interest rate reduction is almost always a good idea, paying a reduced amount or settling your debt could negatively impact your credit score.
Where to get help: You can do this yourself.
- Bankruptcy Sometimes the hole is just too deep, like one caused by a huge medical bill or several years of unemployment. Bankruptcy could allow you a fresh start. But all bankruptcy filings are not created equal. In a Chapter 13 filing, a repayment plan is created to pay what you owe, typically over the next three to five years. In a Chapter 7 filing, the court discharges your debts, and you may lose property. While bankruptcy doesn’t seem to carry the stigma it did in the past, it’s still a big deal that will cost you money and haunt your credit profile for years. It’s also important to get the legal counsel to ensure you do it right.
Where to get help: A qualified bankruptcy attorney
WHEN TO ASK FOR HELP Bankruptcy is a prime example of when you should (and may have to) get outside help. It’s not the only time a third party can provide valuable assistance on your journey out of debt. It could be that you’ve tried on your own and failed, or just want some assistance. Sometimes all you need is an accountability partner. No doubt most financial problems can be fixed on your own, but getting help can make a difference.
Despite all the advertisements, one “resource” that didn’t make my list are debt-settlement firms. These programs can be expensive, drive down your credit score and ultimately result in more harm than good. So steer clear of anything that sounds too good to be true.
Unfortunately, there’s no silver bullet to fix debt issues. Pin your financial security on the fundamentals. Spend less than you earn, save for emergencies, use insurance to protect against major financial issues and have a plan to get to a better place.
J.J. Montanaro is a certified financial planner with USAA Financial Planning Services, one of the USAA family of companies. USAA is The American Legion’s preferred provider for financial services.