The Eight Warning Signs of Debt Problems

Consumer Reports lists eight warning signs associated with potential debt problems. Here are the ones I see violated most often:

Your monthly mortgage payment (including property taxes and insurance) shouldn't exceed 28 percent of your gross monthly income.

You should have enough money to cover six months of living expenses in an accessible account for emergencies. Don't use credit lines as a substitute.

Don't take out an auto loan that exceeds three years. Longer-term loans can leave you "upside-down" with a loan balance that's larger than the car's depreciated value.

I think these are the most violated because many of my friends and family members as well as people who leave comments on this blog don't seem to follow them. In fact, my general sense from reading a variety of financial publications and websites is that the "rules" above regarding mortgage and car debt as well as emergency fund savings guidelines are violated by the majority of the U.S. population.

Here's my personal take on them:

1. You need to buy a house you can afford. Don't know what this means? See Buying a House You Can Afford is a Key Financial Move and MND: Buy a House You Can Easily Afford for more details.

2. Saving for an emergency fund is more important than paying off some kinds of debt. See How to Create an Emergency Fund if you need a step-by-step process for saving for a rainy day.

3. We pay cash for our cars, but only 12% of the people do. The average length of a car loan now is five years or 60 months and ABC News says, "almost 45 percent of new-car buyers are opting for a loan that is longer than six years. Some car manufacturers are even offering eight-year loans on their luxury lines — and the longer the loan, the greater the price tag for the car." Yikes!

Yep, seems like there are a lot of debt-related problems out there. Tick, tick, tick. Hope the debt bombs don't go off for those of you facing these situations.

Comments

[Ryan S]

1. my mortgage payment (full with taxes and insurance) is about 17% of my gross. Soon it will be much less since my wife plans to start working soon. It is nice to be way under the 28% rule even with only one income at the moment.

2. I have the 6 months emergency fund, but I do violate this since I tie up this money in stocks. I'm sure many disagree with that approach.

3. I take auto loans longer than 3 years all the time, but I end up paying off cars in less than a year anyways. My credit union has the same rate for a 1 year loan as a 5 year loan on used cars.

[Darin H]

1. Yep, on one income.
2. we have about 1 year's worth of emergency funds, but we have about 1/3rd of that in a high yield savings account and 2/3rds of it in one year CD (IF there is an emergency then we can break the CD, if not, I make a lot more in interest).
3. Last car I bought I did a 5 year loan and paid it off in 2 years. I wanted the flexibility to have a lower payment if I needed it, but I'm also really good about paying off my debts early. And now we're saving up for our next vehicle (probably a used SUV for my wife).

[Kevin]

1 - We're at about 14% if I count my OT which is all earned from Jan-April. Just counting "normal" 80 hour workweeks we're at about 20%.

2 - We're good here as well and continue to add to the savings for next house downpayment/next car/vacations.

3 - Last 2 cars we've bought have been 60 month loans, but were both paid off early - one in 48 months and the second in about 30. Like Darin, we like the flexibility of a longer term if we need it.

[Cytoman]

1. Our 15 yr mortgage is right at 14% of our gross.
2. We've got 18 months. Although all but 12 months is savings for our next vehicle, house, etc.
3. Of the 5 cars we've owned we've paid cash for all but our first - and that one we paid off in 8 months. One big mistake we made was buying a new high end SUV four years ago. We paid cash but it has since lost 45% of its value.

[Mike Hunt]

I am sure most people who read FMF have no problems here, myself included.

1. Own our place outright / no mortgage. Taxes amount to $1300 per year.

2. Have about 300 months of living expenses in cash reserves / stock holdings.

3. I've always bought cars with cash upfront. My wife though has a 4 year payment for a new Honda because the interest rate was 1.5%. Even if we pay it off early we still have to pay that interest rate so we are paying it month by month.

-Mike

[marci]

1. House paid cash for. Remodeling paid cash for - still under construction due to that. Taxes/insurance $800 month.

2. Several years emergency fund. Over a year of food in the cupboards.

3. Seem to get a better deal if you finance the car, altho I have the cash to pay for one. My car is 8 years old (Subaru) and still good for another 100,000 miles (I hope) so not planning on one soon. Truck is a 74. I g0t a 1.5% interest loan on the car, 5.5 years was the deal, paid extra every month, and paid it off once the 12 mo. prepayment penalty was over.