Dealing with Debt 3 - How Much Debt Is Too Much

by: David Jackson

The amount of debt that is manageable is different for different people. It depends on our income, our bills, and how much money we need to save each month. But in general, it’s best to keep our total debts under 35% of our income. Bad debt is the most important part of the equation. Ideally, we should keep it under 10% of our income. Anything higher is a sign that you may need to reevaluate your finances.

Calculating your bad debt is easy to do. Simply add up your monthly credit card payments, auto loan payments, and any personal loan payments, then divide that number by your monthly income and multiply by 100 for your debt to income ratio. If you want to figure your total debt ratio, add in your student loan payments, mortgage or rent, and any other monthly obligations you have, divide by monthly income, and multiply by 100.

An Ounce of Prevention Is Worth a Pound of Cure

The best thing we can do to avoid ending up in a vicious cycle of debt is borrow wisely in the first place. By remembering three simple things before we borrow, we can keep our debt manageable from the start.

1. Shop around for the best possible rates. When buying a car or a home, we almost always compare several options before settling on one. We should always do the same when obtaining credit. Whether it is a mortgage, a car loan, or a credit card, getting the best rate you can get will end up saving you a lot of money in the long run.
2. Use credit wisely. If you can do without it, you’re usually better off paying cash for it. Many people keep credit cards for emergencies, only to end up declaring a state of emergency when those expensive shoes they’ve been eyeing go on sale. While one impulse purchase probably won’t hurt anything by itself, it can easily become a habit. And that spells trouble.
3. Pay your debt off as quickly as possible. If it’s a mortgage or loan, add a little extra to the payment each month if you can, or better yet make an extra payment every now and then.

For credit cards, pay off the balance in full each month. If that’s not possible, pay as much as you can afford. Paying only the minimum payment each month will keep you out of trouble with the credit card company, but it will also allow interest charges to build up. These steps sound easy, and they are. But it’s also easy to slip up a time or two.

When we do and it doesn’t cause any major problems, we often tend to become more lax on watching our credit habits. That leads to more mistakes, and those mistakes lead to more debt. If it continues, we can end up in too much debt.