Want to achieve Financial Well-being? Smart debt/credit management is a key part of that. Credit is a valuable tool when used wisely. It is necessary to make expensive purchases or to pay for things you may not be able to afford up front. Credit is commonly used to finance purchasing a house, a car, or to pay for university education.
For good debt management and a good credit history, practise the following:
- Only take a loan if it’s necessary, and be sure to get all the loan details, including what’s in the fine print.
- Exercise due diligence before taking out loans for friends and family members. If they default, you have full responsibility for repaying the loan.
- Avoid or limit Credit cards, pay day, and hire-purchase loans, as they come with very high interest rates. You may end up paying for your purchase multiple times!
- Pay bills on time
- Make loan payments on time
A simple rule to remember is that good credit saves you money, while bad credit costs you money.
Poor debt management can lead to a bad credit rating or history (your track record for paying bills and repaying loans), may prevent you from getting loans in the future, and can significantly reduce your wealth.
Debt Service Ratio
The Debt Service Ratio (DSR) is your ability to repay your debts while honouring your other financial obligations. It is calculated by dividing your total monthly loan payments by your gross income, then multiplying that figure by 100. For example, if your total monthly loan obligations (such as mortgage/rent, car loan, credit cards) total $100,000 and your gross income is $200,000, we would divide $100,000 by $200,000, which gives a result of 0.5. If we multiply this by 100, your Debt Service Ratio will be 50%. So, what does this mean?
More than 45%: Your DSR is high in relation to your income, as you are spending 50% of your earnings on debt. Financial institutions typically prefer your number to be less than 45%. You may find it challenging to achieve your financial goals, get approved for loans, and to meet your ongoing financial obligations.
Less than 45%: A score of less than 45% indicates that you are in a good financial position as less than 45% of your income is being used to repay loans. You will find it more likely to access loans to achieve your financial goals.
How to Reduce Debt
If your DSR is above 45%, here are some tips to try to lower it.
- Increase your income – turn a hobby into cash, get a second job, change jobs, or ask for a salary increase
- Decrease your expenses
- Reducing the number of credit cards and/or your credit card limit
- Consolidate your debts to decrease your monthly payments
