Friday, January 6, 2012
Start Your Financial Makeover
By Alden Wicker, Republished from LearnVest
Know Your Starting Point
Before you start on the road to financial fitness, you need to know exactly where you stand. A good place to start is your net worth. This number indicates, for instance, whether you’re likely to meet your retirement goals or whether you have a cushion against unexpected life disruptions like job loss or a medical emergency.
Your net worth is constantly changing, so you can think of it as your starting point at any given moment. It’s calculated by adding up your assets (like savings, investments, real estate or other valuable possessions you own) and subtracting your liabilities (any debts or loans you owe from credit cards, student loans or anything else).
Separate the Good From Bad
Your next step is dividing your liabilities into “good” and “bad” debt. Although it should come as no surprise that we don’t like debt, some debts are definitely worse than others.
The biggest difference between good and bad debt is the interest rate. Good debt has a low rate, 6% or less, whereas bad debt can come with much higher rates. Generally, people take on good debt as an investment for the future.
This category often includes:
• Student loans
• Business loans
A rule of thumb is that good debt is borrowing to buy something that will grow in value over time, like a house or an education (which can bring you more earning power). Better yet, this kind of debt is usually tax-deductible. Just note that good debt can easily become bad debt if you don’t have a solid plan for repaying the loan. As we saw in the housing market crash, a mortgage can be very bad debt if a homeowner can’t afford her payments.
“Bad debt” usually includes:
• Credit card debt
• Car loans
• Consumer loans with high interest rates that are not tax-deductible
Following the same principle, this is the sort of debt that doesn’t grow in value over time: Unlike a college degree that increases your earning potential or a home that may grow in value over time, a car loses value once you drive it off the lot, and credit card debt just keeps racking up.
While having any amount of bad debt is a challenge, if it amounts to more than 20% of your annual income, you might need a serious debt reduction plan.
Calculating Your Top Financial Priority
We can quickly assess your debt load by analyzing how much bad debt you have relative to your annual income; this figure tells us if it’s going to take you a very long time to pay off your debts, and what your next move should be. The tool below, taken from our Take Control Bootcamp, will analyze both your net worth and your bad-debt-to-income ratio to come up with your personal “financial makeover” next steps.
To use our calculator, input the amount for your assets, which you can find here (or add up the value of your checking, savings, investment and business accounts, if you have them). If you own your home, add its current value, which you can find on Zillow.com, and if you own a car, add its current Kelley Blue Book value.
Next, add up your good debts in one pile and your bad debts in another. (If you haven’t linked your accounts, you can still do this exercise by adding up your assets, good debts and bad debts on your own.)
Where to Go From Here
We’ve given you customized recommendations on how to get started on your own financial makeover. Make sure you write down these steps and tackle them as soon as possible. With each task you accomplish, you’ll gain more momentum toward reaching your financial goals.
You might have been told in your advice that you would learn more about this subject in the next few days. That’s because this tool and advice has been excerpted from our Take Control Bootcamp. If you found it useful and want to find out more about these concepts, sign up today to get ten days of easy-to-understand financial advice, delivered straight to your inbox, and continue your financial makeover (www.learnvest.com).
Want more financial advice? Check out our budgeting 101 or savings courses at ww.wehelpwomen.com. They are easy to complete and will get you on the road to financial success!