Do you know how close you are to the financial edge?
Sure, things may be going well now. They should be: the economic recovery is in its 10th year and unemployment is below 4 percent. The Federal Reserve's annual Report on the Economic Well-Being of U.S. Households found that, across a variety of income and demographic groups, Americans are finding it easier to get by than they did a few years ago.
The thing is, that at times like these, life shouldn't just be easier from day to day - you should be trying to get ahead. Now is the time to put a little distance between yourself and the financial edge. When the economy turns sour again - as it inevitably will, sooner or later - you'll survive it better if you use these good times to build up a little bit of a cushion.
Financial Checklist: How to gauge fiscal health
These crucial questions can help you determine how close you are to the financial edge:
- Is the remaining term on your car loan longer than the likely life of the car?
If you depend on your car to get to work, serious car troubles could represent both an unexpected expense and a potential interruption of your income.
Face it - your car has a replacement cycle that requires you to pony up for a new vehicle every now and then. The best way to deal with a replacement cycle is to make sure your car loan is paid off long before the useful life of your vehicle expires.
Unfortunately, Americans have been putting themselves closer to the financial edge by taking out longer and longer car loans. Twenty years ago, the average car loan had a duration of about 4.5 years. Now, the average is about 5.5 years, and even longer loans are available. A long loan is especially dangerous if you are buying a used car or if you are refinancing a car with a few years on it already.
When taking on an auto loan, make sure the loan is unlikely to outlive the useful life of the vehicle. Ideally, the loan should be paid off soon enough to give you a couple years to save up so you can purchase your next car outright and avoid a loan altogether. But at least save enough to make a handsome down payment before the next replacement cycle.
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- Do you have a better credit score now than five years ago?
A stronger job market should give you the opportunity to repair your credit. Paying down debt and establishing a steadier payment history should help you earn a better credit score.
Remember that, during a downturn, credit terms become much tighter. If you don't use the economic expansion as a time to improve your credit score, you may find your access to credit severely restricted or prohibitively expensive during the next slump.
- How long could your emergency fund last between jobs?
Right now, a typical stint of unemployment lasts about nine weeks; but during the Great Recession, the median period of unemployment soared to nearly half a year.
If you found yourself without a job for an extended period, how long could you go before you started accumulating debts, or risked foreclosure or bankruptcy?
To put distance between you and the financial edge, now is the time to build up an emergency fund - accessible savings only to be touched in case of a financial emergency. While times are good, look to build your emergency fund up to where it would cover six months of essential expenses.
Emergency fund strategy: Opening multiple money market accounts is a smart move
- Have you reduced debt balances on credit cards?
Another important consideration - those credit card bills only become tougher to pay during downturns. A growing economy means now is the time to give yourself some breathing room by paying down debt.
In particular, it makes sense to target credit card debt since interest on this debt is particularly expensive. If you haven't yet reduced debt balances on your credit cards, make this a financial priority.
- Have you caught up on your retirement savings goals?
It's hard to save for retirement when times are tight, but with several years of expansion under the economy's belt, you should be actively taking steps to make up for lost time.
Use a retirement calculator to take stock of where your retirement savings stand and what you need to do to catch up to your goals. If you are 50 years of age or older, remember that you can take advantage of catch-up retirement contributions to expand the normal limits on contributions to a 401(k) plan and IRA contributions.
Financial setbacks can be events that take down the whole economy or simply misfortunes that happen to you personally. In either case, you'll be better able to survive them if you use good economic times to put some distance between yourself and the financial edge.