The purpose of this paper is to summarize the importance of debt management and financial stability in an individual's life with personal examples. The article discusses the importance of classifying and examining your debt. Assessing debt to income ratio, assets, credit, and creditworthiness to attract future lending. The paper sheds light on the importance of having good creditworthiness, the importance of credit score, and the benefits of having the right balance. The credit scoring models by the three credit bureaus, Experian, Equifax, and TransUnion helps in forecasting the probability of loan defaults (Mishra, 2010). I will be concluding my paper by discussing comedian Tim Clue, his interpretation of debt, his funny way of addressing this important subject, and its effects on everyday American.
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Importance of Debt Management and Financial Stability
In simplest terms, debt is money owed by one individual to another. In other words, people borrow money from lenders at the time of need. The money they owe back to the lenders with interest is considered debt. Sometimes collateral is provided such as down payment for a loan, which can be re-possessed along with the asset if you don't pay back as per the terms and conditions. For instance, not paying your loan payment on time can result in recouping of the house or car by the lender. The above example is a type of secured debt, whereas an unsecured debt is borrowing without collateral such as credit card. The term unsecured debt doesn't necessarily mean you can get away without paying it. It will affect your credit and affect your ability of future borrowing. According to Smart Asset, the ideal debt to income (DTI) ratio is 36% for mortgage loans (Josephson, 2018). To calculate liability to income ratio, you divide your total monthly debts with your gross monthly income. This percentage helps lenders in making crucial lending decisions. If your DTI is too high, it may be too risky for lenders to lend any more money until the ratio comes down. If you can manage that ratio between 18% to 36%, that would be the ideal situation in terms of borrowing. My DTI is 36% at this moment, it is considered a ratio in the housing market, but I'm working towards to bring it down a little. To reduce debt, first, we need to asses individual debt, set up realistic monthly financial targets, and identify any smart savings as a result (Sieger, 2013). I should see a difference by the end of this year once my brother moves out but currently, I'm helping my brother build his credit. I have a car loan that is under both of our names as well as credit cards to help him settle into better future opportunities.
Credit means borrowing in financial terms, one's ability, and amount to borrow. Credit is a confident representation of your reputation as a borrower. It assists lenders to determine your capability of paying back and the amount you will be able to pay back. Your credit reports provide the insight and historical data of borrowing history. It generally shows the history of past seven years, which includes any loans, line of credits, borrowing, minimum payments, payment history, delinquency, public records on bankruptcy or foreclosure and any collection accounts. Any unpaid debt reflects negatively on your report. Credit is borrowing money from a lender where you don’t immediately pay back but promise to return the borrowing in a future date. A finance charge gets added to the balance that is recurring and not being paid promptly. In the United States, living without the credit is extremely difficult. Credit is an integral part of financial power. Having good credit helps you get things when you need the most. For instance, having a good credit helped me purchasing the house at the right time when the interest rates were an all-time low. Luckily, I was able to lock 3.625% APR on my home loan. Now, if my credit were not pleasant, it would not matter how good of an APR it is because I would have never been qualified for the loan and take advantage of the low APR.
Credit plays a vital role in an efficiently growing economy. When people and industry can successfully borrow money, they can see growth and automatically help the economy grow as well. Credit also help people with the ability to afford and procure expensive things such as home, college, cars, etc. and the possibility to pay overtime while retrieving essential products at the time of need. There are more benefits to having the ability to borrow that can improve your standard of living. For instance, a loan can provide access to good colleges; completing higher education can increase the power of earning. Loans can enable wealth building, a small business that borrowed funding for a loan to start a business can boom and add more jobs and maintain an operational economy.
I have a couple of assets to secure my debts. I have a house, car, 401k, and Roth IRA. My house value has been continuously going up according to the market, but in the last six months, there is continues upward trend since Amazon has announced they will be opening one of their two headquarters in Virginia. I have a 401k, Roth IRA, and the Federal Employees Retirement System (FERS). I contribute 4% on my 401k, and Army matches 4% towards my 401k. Besides that, I have started adding 1-2% towards a Roth IRA. I also contribute 4.4% towards FERS, which gives me additional retirement, disability, and survivors benefit in the future.
The biggest debt I have is my house, and it is also the most extended term. I still have 27 years left to finish paying my mortgage. My original loan was $304,000 extended over 30 years. I owe $289,836 as of right now. My interest rate is 3.625%, and monthly mortgage, and the principal payment is $1,386.40. I recently learned that paying off mortgage slightly faster can save thousands of dollars in interest payments (Anonymous, 1988). I have done some recent calculation and conclude that if I start paying extra $200 towards principle every month from next month, I will pay off my house five years four months faster, which will be 18% faster. I will then save interest payments worth $36,443, which is 19% savings. If I follow the schedule accurately, I should be able to pay my house off by August 2041 instead of December 2046.
There is another more aggressive approach I have thought about; I get two extra paychecks in a year one in March and another one in August. If I don't spend that money and directly apply to my principle yearly. I can pay off my mortgage ten years five months, at the pace of 35% faster. I will also be saving in interest payments $70,650.27, which will be 36% savings. Instead of paying off my mortgage by December 2046, I will be able to pay it off by July 2036. I'm seriously considering this option as it does sound aggressive approach, but it is possible since I'm ready to afford my bills with two paychecks every month.
Debt may come across as, but if appropriately utilized, it has many positive benefits that affect an individual's life. Debt can help to build wealth. As my above mortgage example, you can see that borrowing a large amount of loan to buy my house at a lower interest rate increased my debt but also gave me the ability to afford the property faster. Once I own the home, I can invest my money in other avenues to increase my wealth. I can make property improvements, invest in new properties or retirement properties, stock markets, business, etc. Reinvesting the dollars earned will only multiply and generate more money, even if you make conservative investments. I'm taking full advantage of the Army's tuition assistance program to pay for my education; in return, I have to give them four years of service. I'm planning to finish my bachelor's program by December 2020. I have decided to pursue my masters in summer 2020 by applying for the same program and signing another service commitment with the Army. One of the essential aspects of the federal position is clearance. Having good credit that has helped me maintain my security clearance and my job. In return, I have these educational benefits that make me more marketable for future positions. Once I retire from federal service, I can always come back as a contractor and make twice as much as I'm making right now.
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When lenders are reviewing the borrower's credit, they are looking at five characteristics of credit, also known as the five C's. The bank evaluates the borrower's credit character, credit history, capacity, capital, collateral, and conditions. Fair Isaac Corporation (FICO) is the most extensively used credit score in the industry; the range of score is anywhere from 300 to 850 (Holmes, 2011). We must continuously monitor, bring improvement, identify, and fix any discrepancies to protect our credit score for life (Weston, 2004). According to credit secure by American Express, my credit score is 810. I have very minimal factors that affect my ratings, either my history is not long enough, or I don't have enough accounts. I have no negative ratings on my accounts or anything in the last ten years. I’m easily affording my payments for my debt, and I also have the possibility of reducing my current liability. I own one vehicle that is worth $25,000. I have $10,000 in my savings account. It used to be significantly more substantial, but I have invested those savings in house and other meaningful life-changing events. Now to protect my significant other with these debts, I have a one-million-dollar life insurance policy privately, in case something unfortunate happens to me. I also have half a million-dollar life insurance policy with the Army from my work. In the unforeseen circumstance, if I met with untimely death, these securities can help my significant other and immediate family members to overcome not only my debts assist them in safely securing their financial future during a tough time.
If I review my five C's, I would determine myself as a low-risk borrower. I have a federal job, and my significant other is a contractor, even if he loses his job, I will still be getting my salary. We always explore more creative ways to save money, sometimes we are good at it, and sometimes we enjoy life. It is essential to keep the right balance. It is a seller's market; in an emergency, we can always sell the house, but I don't have too because I can always rent it and make money on it. The area I live is an excellent opportunity for rental properties due to higher military traffic. I have excellent credit and good credit score; I have an impeccable history of timely paying my loans and payments. Lastly, I have a low income to debt ratio; I would like to change the rate more towards the lower end, which I will be able to once my brother settles down.
Now I will chime in some wit into a serious discussion. Tim Clue is a famous comedian and motivational speaker who did a comedy skit on his take on debt management. Tim Clue presents the whole comedy act as rudimentarily funny that touches a raw truth of life. It sounds weird when he cracks jokes about discussing real-life scenarios where people get harassed every day from debt collection agency may not come across funny to some. It is a positive way to look at a hard situation in life but not necessarily practical. He consistently jokes about these debt collectors, but in real life, it can be harrowing and embarrassing. Sometimes people may have circumstances beyond their control that may have put them in that tough situation. Unfortunately, in real life, death happens, divorce happens, cancer happens. You can prepare as much as you want, but sometimes you may not be able to influence the outcome of life. In those scenarios, we need to strategically work towards building our score by directly paying your debt (Hodges, 2015). Tim Clue's humor continues by taking jabs at companies who consistently mail credit card offers. I receive them all the time, including debt consolidation letters that I look and toss right into the garbage bin.
In conclusion, debt management and financial independence are not quite easy to obtain, but it is quite possible to achieve the goal if one plans realistically appropriate, make good lifestyle choices, put in hard work and effort to make the right choices. Apply the right concepts and work with a financial advisor you may reach the financial freedom which can improve your life. There are no quick ways to become wealthy, but if you start putting in plan forward today, you will only get a step closer tomorrow.
- Anonymous. (1988). How to build savings into your home: paying off your mortgage a little faster can save you thousands of dollars. Consumer Reports, 54(6), 368–369. Retrieved from http://search.proquest.com/docview/217484133/
- Hodges, D. (2015). How to improve your credit score. MoneySense, 17(1), 17. Retrieved from http://search.proquest.com/docview/1652940902/
- Holmes, T. (2011). How to Get at Credit. Black Enterprise, 42(1), 54–56. Retrieved from http://search.proquest.com/docview/887544985/
- Josephson, A. (2018). What Is a Good Debt-to-Income Ratio? Smartasset, 21(2), 4–5. Retrieved from https://smartasset.com/credit-cards/what-is-a-good-debt-to-income-ratio
- Mishra, S. (2010). Credit Scoring Models: A Review. GITAM Review of International Business, 2(2), 1–25. Retrieved from http://search.proquest.com/docview/1705546806/
- Sieger, M. (2013). 6 Tips to Reduce Your Debt. Realtor Magazine, 46(2). Retrieved from http://search.proquest.com/docview/1328173757/
- Weston, L. (2004). Your credit score: how to fix, improve, and protect your credit for life. Indianapolis, IN: Prentice Hall Professional Technical Reference.
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