Part V of the Credit Card Series: Start at the beginning if you missed a part.
Before we discuss debt, the best advice is: Do not incur debt.
If you have to incur debt to survive, pay it off at the end of the month. Many people have no alternative but maintain debt. They can learn to budget to conquer it. We will explore ways to save during the battle. Before you incur debt, you need the following advice:
How much debt can I handle?
Since you know you could be paying three times as much for your purchase, consider carefully how much debt you incur on your credit card. There is a simple method for determining how much debt you can afford.
(Total Personal Savings/2) – (Credit Card Debt x 15%) = $0
“Wait a minute! $0?” Do not panic. Let’s apply a little algebra to the equation:
Total Personal Savings / 30%
What is personal savings?
At the end of the month, the money you have left over is personal savings. This is the remainder of your income after taxes and personal expenses (bills). Remember how we built your emergency fund from your personal savings?
Why cut it in half?
Even while you are paying down your debt, you still need to be saving. If you have your emergency fund complete, you should be using at least half of your monthly personal savings to pay down secured debt (mortgage) or invest in retirement. The remaining half is what we will use to calculate how much debt you can comfortably handle.
Where did you get 30%?
Multiplying the 2 (denominator from 1/2) and the 15% (from the amount of credit card debt) equals 30%, or 0.30.
I am algebra-phobic.
Example: Your personal savings each month is $1,000. Divide that by 30%. You can comfortably carry $3,333 in credit card debt.
For every $1,000 in personal savings, you can carry $3,000 in debt without spending all of your personal savings each month only on credit card debt.
Do not look at $3,333 and think you will be paying it off in three months. Have you forgotten the interest and fees? If you are paying 10% of the balance ($333 each month, regardless of the minimum payment on the bill) at 31% interest, it will take you one year and nearly $4,000 to pay off the debt.
That is too much!
Before you run out and purchase your maximum on your credit card, consider two options:
(1) Only incur half as much debt as you can comfortably carry.
(2) Pay twice as much toward your debt.
If you did not take the best advice at the beginning, take this piece: Choose both.
NEXT: What if you are already over your debt limit?