Blinking Red Light of Debt- or Death

The world has been watching carefully to see how America would juggle its massive financial obligations.  Even though Congress and the President found a temporary solution to avoid default, we still have some major decisions to make.

The question of what constitutes safe debt levels is on everyone’s mind.

What is considered a sustainable amount of debt vs. a blinking red-light warning of disaster?

As of June 29, 2011, the Total Public Debt Outstanding of the U.S. was $14.46 trillion, which is approximately 98.6% of 2010's annual gross domestic product (GDP) of $14.66 trillion.

Economists generally agree that debt levels exceeding 90% of GDP is dangerous territory.  If that’s indeed the case, America is not alone. Look at the debt vs.GDP ratios of these countries:

Ireland - 93%

United Kingdom - 94%

Portugal - 97%

France - 99%

Greece - 130%

Italy - 130%

Japan   204%

Japan’s debt is double that of the U.S. and yet their financial woes are not splashed all over the evening news. Why? The US media moguls are masters at using the “shock factor” to gain eyeballs. More viewers means more advertisers.

What is not being reported is the fact that countries need a certain amount of debt to fuel their economies. Less than 70% debt vs GDP has been proven to actually stall an economy.

In order for the U.S. to balance it’s books, we need to cut back spending and increase GDP. Contrary to liberal belief, taxing the rich is not a solution.

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Higher taxes can actually stall GDP growth. If business owners are forced  to pay more to Uncle Sam, they will have less to invest in new employees. New employees pay taxes, and the government still gets its revenue. But new employees also stimulate the economy by spending their paycheck on goods and services.  Would you rather the government decide where to spend money or the individual? Individuals will reward the companies that are most deserving of their hard earned money.

70% of our GDP is fueled by consumer spending. When people don’t have jobs, they don’t spend.  Government stimulus programs are intended to get money circulating back into the economy, but that’s only a band aide approach. Lending that stimulus money to solid businesses is more sustainable.

Consumer debt is another reason GDP growth has stalled. In 2007, U.S. borrowers reached the maximum debt load they could handle at a whopping 130% of income. With no way of paying off that kind of debt or even the interest on it, consumers were forced to default or stop spending to pay down debt. 

By May of 2011, consumer debt was down to 117%. In order to get back to 90% debt to income levels, consumers need to unload another  3-4 trillion dollars. Again, the fastest way to pay off this debt and get our economic wheels turning is to create jobs. Taxing the employer to death is not going to help.

What do bankers consider healthy debt?

Mortgage bankers look at “back end ratios” when considering your creditworthiness as a potential borrower. Ideally, your total monthly long-term debt payments (including your mortgage and credit cards, child support, alimony, car and college loans) should not exceed 36% of your gross monthly income. 

To calculate a healthy debt ratio, you would multiply your annual salary by .36 and then divide by 12. That’s how much you should be paying toward debt obligations.

Your “front end ratio” is the percentage of your gross (pretax) income that would to toward your housing expenses, including your mortgage, taxes and insurance payments. Bankers expect your front end to be 28 percent.

To calculate a healthy housing expense, you would multiply your annual salary by .28 and then divide by 12.

To calculate the health of the housing market in your area, the average home price must be no more than 2-3 times the average income. High priced markets may continue to experience price declines because the days of stretching to make a payment are gone.

Kathy Fettke is CEO of www.RealWealthNetwork.com, a California based real estate investment group that offers free education, resources and referrals to wholesalers with a proven track record.