There is a lot of talk right now about allowing for a higher debt ceiling for the United States’ spending needs. Because the creation of debt should never be limitless, Congress set a cap on the amount of debt that the U.S. could comfortably have. Since we’ve reached that limit, we can no longer create more debt unless the ceiling is raised.
Your Debt Ceiling
You may not realize it, but you and your family have your own debt ceiling too. By default, your debt ceiling is the amount that creditors are willing to lend you. Creditors determine what your ceiling (or limit) is by looking at your credit report, FICO score and income. They look at your payment history with other creditors, your likelihood of default as estimated by your FICO score, how much untapped credit you have in your other accounts, and then they decide — based on these factors and others — what they are willing to risk on you.
But relying on a creditor’s assessment of your finances is not the best way to create your debt ceiling. Instead, you should determine what amount and kind of debt you and your family are willing to take on based on your future financial goals, current financial situation and your attitude toward debt.
Creating Your Own Debt Ceiling
Your debt ceiling should never put you in a position to have to choose between paying credit card payments on time and saving money. Instead, your debt ceiling should create harmony between the purchase of big ticket items and investments, paying bills, and saving.
1. Budget debt repayment: Your debt ceiling should never be so far removed from your income that it is an amount you could never pay off with your current salary. When creating a debt ceiling, it’s not a good idea to anticipate salary increases that you don’t know will happen. Instead, choose a number that could conceivably be paid off with your current income and still allows you to set aside money for emergency and retirement savings.
2. Assess potential debts and assign quality ratings: Now that you know how much your personal debt ceiling is, it’s time to decide how to allocate it. Going into debt to buy a new home makes sense. This is the kind of debt that is expected, since few can pay for homes with cash, and is often a sound investment. This would be considered a high quality debt and one that you could accept in a large dollar amount. But credit card debt, used to buy morning coffees and impulse items, is high interest with low return making it a low quality debt. Break your debt ceiling into segments to allow for a limited portion of the total debt to be allocated to high, medium and low quality debts.
3. Set review dates: as your income grows, you may want to increase your debt ceiling. The time to increase it is not when you have reached the ceiling amount and are standing in the store desperate to buy some new toy, however. Instead, have annual family meetings to discuss your savings, earnings and debt ceiling.
It’s never a good idea to let another person or business set limits for you. If you want to retain the maximum control over your financial life, don’t trust what others think you are capable of. Take the time to set your own limits based on your priorities and what you know you can handle responsibly.
When you create a debt ceiling, you decide how much money you are willing to owe and pay interest on while helping to control your financial future.