Dear Dollar Stretcher,
They say rent should be a third of your salary, or something like that.
How much should be allocated to credit card debt if you made the
mistake of getting into debt?  If I paid each credit card a little bit, I’d
still owe about $400 a month.  What should my income be to pay that much
each month but still not be in trouble? For instance, if I only earned
$1,200 a month, I couldn’t be expected to pay rent, food, etc., AND
credit cards. But if I was making $100,000 a year, $400 a month wouldn’t
seem like much. Is there a way to calculate this?
Linda

Approximately 1 in 3 of us have at least one credit card with a balance
due. And with a new law that required higher minimums taking effect in
2006, more and more consumers are wrestling with their minimum payment.

So Linda asks a good question. How much debt repayment can I fit into
my budget? And, yes, she’s right. Someone with a $100,000 annual income
can afford more than the person who takes home $1,200 each month. So
let’s see if we can’t come up with some guidelines for Linda.

Most family budgets are dominated by three categories: housing, auto
and food. Combined they typically take up 65 to 70% of the budget. That
leaves 30 to 35% for everything else: insurance, clothing, medical,
dental, entertainment & vacations, education, property taxes, savings, and
debt repayment.

Most of these categories will require between 3 and 7%. Which will
quickly consume the remaining portion of your income. Each family is a
little different but most families can commit about 5% of their paycheck to
repaying debt without twisting their budget out of shape.

How does that work out in Linda’s case? A monthly payment of $400 is 5%
of $8,000. So Linda would need to be bringing home $8,000 after taxes
to hold to this budget. I hope that she is making $96,000 a year. But,
there’s a good chance that she’s not. So she might need to make some
adjustments.

Even if she is making that much money, it’s still wise to pay down her
credit card balance. That’s because it is unlikely to stay at the
current level. The reason is simple. Life happens.

There will always be ‘unexpected’ home and auto repair bills. Even with
good medical insurance the deductible on a broken arm can be
significant. And taking a nice vacation is real tempting.

If Linda is struggling already she probably doesn’t have money saved
for these ‘emergencies’. So they’ll go on her credit card. And, that will
boost her balance. The new minimum will only go up a little bit. But
the hill she’s climbing just got a little steeper.

The sad part is that many people fall into credit card debt because
they can’t afford to completely pay for whatever they bought during the
month. Trouble is the interest that they’ll owe only makes the original
purchase more expensive. So they’ll pay even more for something that
they couldn’t afford in the first place.

So what can Linda do? Take aggressive steps to pay down her credit card
balance. Beginning now.

The biggest opportunities are where she spends the most - housing, auto
and food. It may be time to move to a smaller home or apartment, or
take in a roommate. Replace an expensive car with a cheaper one. Commit to
eating at home until her debt is paid off.

Linda should also look for ways to make small contributions to her
‘debt repayment fund’. It’s time to consider dropping premium cable
channels, mocha lattes and other non-essentials. You’d be surprised how
quickly these items can add up to a sizeable amount. Not only will she be
reducing debt, she’ll feel better about taking steps to reach her goal.

Some of these may seem overly drastic. But they are meant to be
drastic. Linda is heading for a financial wreck.

Here’s how it will unfold. ‘Unexpected’ expenses will add to her
balance and her monthly minimum. If her minimum payments begin to exceed 5%
of her budget, she’ll soon find herself unable to make the monthly
payment.

Then things will snowball. Each month she’ll struggle to make all the
minimum payments on time. One day a payment will be a little late. Her
interest rates will go up. On all of her cards. That’ll increase her
minimum payment. That, in turn, will make it almost impossible to cover
the new minimums. Her credit rating will go down. She’ll trigger a chain
of events that will take up to ten years to correct.

Linda is wise to correct it now while she still has time. Some of the
steps she’ll need to take will be painful. But she’ll be avoiding much
more financial pain in the future.
_______

Gary Foreman is a former financial planner who currently edits The
Dollar Stretcher.com website. You’ll find hundreds of ways to help make the
most of the money you already earn. Visit today!