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8 Benchmarks for Borrowing

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Consumer Reports – July 2008 issue – has a good article on the 8 Benchmarks of Borrowing.    Follow these guidelines to avoid falling into financial distress.

1) 20% – Add your monthly car payment, average new charges on your credit cards, & other non-mortgage debt payments.  The total should be no more than 20% of your gross monthly income.

2) 28% – PITI – Your monthly mortgage payment (including property taxes and insurance) shouldn’t exceed 28% of your gross monthly income.

3) 36%-48% – Ideally, your total monthly debt payments shouldn’t exceed 36% of your gross monthly income.  Many people go above 48% – which should be avioded.

4) 80% – The total amount borrowed on your first mortgage, plus any second mortgage, home-equity credit line, shouldn’t be more than 80% of the property’s value.  The lower this debt-to-equity ratio, the better.

5) 6 pts. – Low introductory interest rates make Adjustable-Rate-Mortgages look affordable.  Most ARM’s come w/ a lifetime cap of 6 percentage points.  If you are considering an ARM, add 6 percentage points to the “teaser” rate, then calculate the monthly payments under the higher rate.  That’s your worst case scenario; if the result (with taxes and insurance) exceeds 28% of gross monthly income, dump this deal.

6) 6 months – 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.

7) 36 months – Don’t take out an auto loan that exceeds 3 years.  Longer term loans can leave you “upside-down” with a loan balance that’s larger than the car’s depreciated value. 

8) 650-700 points – You’re generally considered a sub-prime borrower if your FICO credit score is below 600 for auto loans and mortgages and below 700 for premium credit cards and 650 for classic cards, says John Ulzheimer, president of consumer education for Credit.com, a loan information and referral website.  If your credit score falls below those thresholds, you’ll pay higher interest rates.

Article courtesy of Consumer Reports July 2008 Issue

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