All signs point to a full recovery and consumers seem confident to borrow again.
The recession sent the American credit and lending industries off into a ditch. Home loan and credit card defaults skyrocketed, and at the same time, lenders stopped issuing new loans and lines of credit because there was simply too much risk of non-repayment.
However, according to the newest National Consumer Credit Trends Report from Equifax, all economic indicators seem to point to a full recovery:
- New credit card issuing has hit a 6-year high
- Credit card defaults have dropped to a low not seen since 2005
- Mortgage defaults have dropped to a 7-year low
- The number of new auto loans has hit an 8-year high
“Every indicator seems to say that we’re out of the woods when it comes to the credit crisis we’ve stuck in for the past few years,” says Gary Herman, President of Consolidated Credit, “but that doesn’t mean that consumers should take up all of the old habits that started the crisis in the first place.”
So while you can feel more confidence in our economy and may even start to feel more comfortable taking on new debt, that doesn’t mean you ignore the important lessons we learned from the global recession.
Consolidated Credit offers these tips to help ensure your finances stay solvent even if the economy goes south again:
Keep a close eye on your debt-to-income ratio
Your debt-to-income ratio (DTI) is one of the most important factors in your financial health. You have to make sure that your debt payments don’t outstrip your income to cause problems for your budget.
You need a 41 percent or lower DTI to qualify for a new mortgage, but Consolidated Credit actually recommends maintaining your DTI at less than 36 percent to promote financial stability. If your DTI goes higher than 36 percent, look into options for debt consolidation to eliminate debt quickly.
Be overly cautious when it comes borrowing
One of the main reasons for the mortgage meltdown in 2008 was that borrowers (and lenders) were far too comfortable with loans that couldn’t be afforded. Consumers applied for adjustable-rate mortgages with almost nonexistent down payments because they could. However when interest rates rose and home values dropped, homeowners were left with a mess.
The lesson here is just because you can get approved, that doesn’t mean that you need – or can afford – the loan. Modern loans with adjustable interest rates and low down payments make things like mortgages accessible to more people, but they don’t make it easier to pay the loans back. In fact, these modern loans usually make it harder. So aim for traditional loans with fixed interest rates and try to provide the highest down payment possible to limit what you’re borrowing.
Keep credit card debt low
Don’t carry around balances on your credit cards. Pay off debt as quickly as possible. Eliminating credit card debt quickly minimizes your added interest charges and helps you avoid financial distress. It’s also good for your credit score, because you’re not utilizing all of your available credit so lenders see you as a low risk borrower.
Expand your savings / diversify your portfolio
A financial safety net helps you avoid trouble when there are fluctuations in the economy or in your own life because of unexpected events. Try to maintain 6-8 months of budgeted expenses in short-term savings. This means you could lose your job and live for 6-8 months without turning to your credit cards to carry you.
At the same time, look at your long-term savings. When the stock market plummeted in 2009, it wrecked many people’s long-term saving strategy because things like 401(k) accounts were left with almost nothing.
“Having all of your financial eggs in one basket is never a good idea,” Herman adds. “The more you can diversify your holdings and have different types of long-term savings, the better prepared you’ll be if the market takes a turn.”