Dear Liz: I pay off credit card debts. What debt-to-income ratio would you consider my personal finances to be healthy?
Reply: The healthiest level of credit card debt is zero. Credit card interest rates tend to be high and variable, making this type of debt toxic to your financial health. Congratulations on making progress in removing yours.
There are a number of metrics you can use to determine if an appropriate amount of your monthly income is being spent on debt repayment. Among the most common:
◆ Traditionally, mortgage lenders have preferred home loan payments to be 28% or less of your gross monthly income and total debt payments, including the mortgage, to be 36% or less.
◆ Debt payments, including mortgages, that exceed 40% of the gross monthly amount can be an indication of financial distress, according to the Federal Reserve.
◆ Under the 50/30/20 budget, all of your essential expenses – including housing, utilities, transportation, insurance, and minimum loan payments – would be 50% or less of your after-tax income (your gross income minus income and payroll taxes). This leaves 30% for needs and 20% for savings and additional payments on debt. If a loan payment is less than the 50% limit along with all of your other essentials, then it can be considered affordable.
You usually don’t need to rush to pay off low-rate, potentially tax-deductible debt, such as mortgages or student loans. Still, you’ll probably want all of your debt paid off in retirement so you don’t use up your nest egg to make the payments.
Speaking of retirement, are you saving enough to reach this goal? Do you have sufficient emergency funds? Are you sufficiently insured? Are you able to enjoy your life without undue stress about money? Financial health includes all of these components in addition to debt repayment.
Don’t rush to start collecting social security
Dear Liz: After reading your Social Security advice many times, I have a hard time encouraging a friend who reached full retirement age last year to start collecting her benefits. She said her social security was not enough to live on and she had to work two more years before getting paid. She said that if she waited to apply, it would increase her Social Security by $ 400 per month. I informed her that she can both collect and continue to work without penalty as she has reached full retirement age. She would also get an annual increase based on her income, in addition to the annual increase in the cost of living. She didn’t want to tell me how much her Social Security would cost now, and I didn’t ask, but told her it was extra money that she could invest.
Reply: Are you sure you read this column?
There is a lot of research showing that most people are better off waiting as long as possible to apply for Social Security. Given the life expectancy at age 65, most of those who do make it that far will live past the break-even age where the larger checks they receive will more than make up for the smaller ones. they will pass.
The wait is especially important for a couple’s highest income, as it is this that determines what the survivor can live on. The wait is also important for singles because they don’t have the income of a partner to help them. Single women are at an especially high risk of ending their days in poverty, which means maximizing their social security is usually the right decision.
In addition, no risk-free investment would guarantee an annual return of 8%. This is what she gets while waiting to start her social security benefit (at least until the age of 70, when the benefit reaches its maximum). She might be able to generate similar returns with investments in the stock market, but she might also lose her shirt.
Something else to consider: Benefits are based on our top 35 paid years. If she earns more now than in any of those previous years, she could increase her profits even more by continuing to work. People who have taken time off to raise their families or who had a history of low wages or working part-time often see a greater benefit in continuing to work while waiting to apply.
Liz Weston, Certified Financial Planner, is a Personal Finance Columnist for Nerdwallet. Questions can be sent to him at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at AskLizWeston.com.