When considering how much debt they may take, many people make decisions based on their current base-case scenario: for example, two working spouses, decent return on investments, no huge health-care bills, etc. That way of decision making, however, neglects that good circumstances may not last. A just manageable debt today can easily spiral out of control with one life-event change like losing a job, death, divorce, having to relocate, etc.
That is why you should keep in mind future scenarios when you’re making decisions about taking or financing new debt. Instead of just looking into whether you can make the payments today, consider the impact of this additional payment in the future if your situation changes.
In addition ask yourself: Do you have savings that can help you maintain your lifestyle and make your debt payments on time until you restore your income? If not, will you be able to get rid or sell your financed possessions? Answers to these questions will determine the viability of your decision to incur more debt. If you wouldn’t have any source of income or cash that help you stay afloat until the situation changes, you probably need to scale back on new debt.
Here are a few ideas to keep in mind.
Calculations
Before you even begin to approach lenders for more credit, you must know exactly how much debt you have and how much you owe monthly in bills, rent, etc. Next, look at your income and look at how much you will be able to pay every month if your income is slashed in half. Will you have to make up for the drop by dipping into your savings? Do you even have savings? If not, what’s is your contingency plan? Although many may see that as an unrealistic exercise, it is in reality slightly too optimistic. Job security is often overrated, and your job may be at risk just like anyone else. Your debt must be somehow slightly with the ups and downs that might happen within its term. Otherwise, you’re just setting yourself up for trouble down the road.
In addition, consider any potential increase in your expense within that term of this new loan. Are you expanding your family? Any higher tuition or rent payments are on the horizon? In short, because debt is a medium- to long-term matter, make sure you don’t just make your plans based on today’s arrangements. Many lenders lure borrower with a low monthly payment and longer terms (like 72 months). What you need to think of is how far your situation may change within that period.
Types of debt
Debt isn’t all the same. If you’re financing a car, you probably can sell it even at a loss and get rid of the payments if you lose your job or just hit by a similar crisis. But if you’ve taken a personal loan for a vacation, education or rent, you’ve no asset to return. That is why it is important to look into what type of debt you’re walking into. In addition, don’t overlook the fine print that many lenders have. Back to the car-financing example, would the lender allow you to settle the loan early without a penalty? Will you be forced to pay part or all of the interest charged on the principle? All of these questions and their answers determine if you’ve a viable exit strategy or not. The more complicated it is to get out of a loan, the more likely you will be stuck with the payments. That is why it is essential that you shop efficiently for good lending terms even when taking more credit makes sense and you don’t see immediately a reason that you will need to settle early.
Rania Oteify, a former Gulf News Business Features Editor, is a Seattle-based editor.
