Debt is notoriously stressful, breaks up marriages and can lead to depression. Sadly, it is so commonplace that some people overlook it. Having large amounts of debt on your balance sheet may not seem like a big deal. The typical American citizen has more than 92,000 dollars in debt[1]. And yet, this situation is detrimental to the health of your finances.
We invite you to read on to find out the acceptable level of debt and the different ways to check if you are struggling with it. Suppose you have an excessive DTI (debt-to-income ratio). In that case, you should consider a debt consolidation loan or other alternatives to alleviate debt, such as debt settlement or credit counseling, to address your over-indebtedness.
“Paying only the minimum required on credit cards can be a sign of over-indebtedness,” said Kevin Lunn, independent certified financial planner in San Diego, California. “While your accounts will remain in good standing, the balances will slowly decrease and you may end up wasting money on interest charges. It is important to carefully consider your financial situation and make sure you are able to make more than the minimum payment in order to pay off your credit card balances in a timely and cost-effective manner.”
At what level of indebtedness can we talk about overindebtedness?
Your debt level should remain as small as possible to have some financial leeway in case of an emergency and to reach your future objectives. You may have reached your debt limit if you have trouble making monthly payments. Above what amount of debt can we talk about excessive debt? According to the Consumer Financial Protection Bureau, it is recommended to maintain a debt/income ratio under 43%. From a statistical perspective, people with more than 43% debt often have difficulty keeping up with their monthly payments.
On the other hand, the maximum ratio you can achieve that would still allow you to be granted a qualified loan is also 43%[2]. If you are planning to buy a home soon and a monthly mortgage repayment would put you over 43%, it is best to reduce your debt before beginning to explore the housing market.
“I would recommend taking a holistic view of your debt and financial situation. In addition to looking at your debt-to-income (DTI) ratio, consider the overall impact of your debt on your finances. If you are having difficulty paying your bills and using credit to cover expenses that are not reflected in your DTI, it may be a sign that you are overextended,” Lunn said. “If you have missed one or two payments and your creditworthiness has suffered, it is likely that you are carrying a significant amount of debt, even if your DTI is below 43%. It is important to carefully assess your financial situation and take steps to address any debt issues in a timely and responsible manner.”
How is it done to calculate the DTI (debt/income ratio)?
To measure the impact of your debt on your finances each month, simply get your monthly debt total and split it by your income per month. However, this debt does not reflect every expense you have each month, but the following items:
- Month-to-month payments on the credit card;
- Compensatory allowance;
- Child support payments;
- Mortgage or monthly rent payment;
- Lending payments (like educational loans and car loans).
Some items should not be counted in your DTI, such as:
- Cable television;
- Cell phone service;
- Utility service;
- Household gas;
- Food shopping;
- Insurance coverage;
- Internet access;
- Monthly memberships.
If you make $3,000 per month and your monthly expenses are $1,000, then your debt-to-income ratio would come to 33% ($1,000 / $3,000 = .33). This number is acceptable and is generally seen as not too much by lenders.
Do debts have an impact on your creditworthiness?
Yes, especially if it involves a debt on a credit card. Your actual score is determined by five factors, which include your credit utilization. Revolving credit represents roughly 30% of the FICO score.
Over what amount can we talk about debt on a credit card? Most creditors and lenders take a dim view of using over 30% of the available credit. Should you use more than 30% of your available credit line, they will consider that your finances may need to be healthier.
Which debts should be of concern to you?
There are numerous and varied types of debt, but not all are equal among lenders. Some are called “positive debts,” while others are not.
Good debts
Good debt enhances your long-term net worth or has sustainable value[3]. For example, in the case of buying a home or pursuing an education. Real estate generally increases in value over time and is an excellent investment because selling it means you get more money than you invested. In addition, a university diploma gives you the opportunity to get a well-paid job and earn more income over a lifetime.
Bad debts
In contrast, bad debts don’t pay off[4]. They include expenses incurred because you lack the money to pay them. They contribute nothing to your wealth and have no long-term value, as opposed to positive debts.
“Carefully assess your financial situation if you find that a large portion of your debt is comprised of bad debts,” said John Lee, Certified Public Accountant in Dallas, Texas. “This may indicate that you are living beyond your financial means. To address this issue, it is important to create a budget that works for you and allows you to enjoy yourself while still paying your bills and saving for retirement. By taking a proactive approach to your financial planning, you can make sure that you are able to live within your means and achieve your financial goals.”
How to tell if your debt is too high?
Here are different scenarios that indicate a debt problem:
- You are living from payday to payday.
- You use credit cards to pay for essential purchases.
- The amount of your debt is not decreasing despite making steady payments.
- You lack an emergency fund and cannot start one.
- All of your debt takes up over 50% of your earnings.
- You fail to subscribe to a retirement fund.
If you recognize yourself in any of these cases, it’s time to make changes or ask a professional for help.
Where to turn for help if you’re struggling with excessive debt?
If the debt negatively impacts your daily life and you’re wondering how much deficit you have, consider seeking assistance to deal with it. The following are a few possibilities.
Debt consolidation
A loan for debt consolidation is an option. In this case, you borrow money to repay your outstanding debts. Such loans usually have significantly cheaper interest rates than credit cards, so a more significant proportion of your payments each month goes to the capital of the loan and less to interest. It means you can be debt-free faster. What’s more, you make only one payment per month.
Financial counseling
Alternatively, you might consider reaching out to a financial counseling service to help you develop a workable budget that fits your lifestyle needs. Many places provide inexpensive or free advice about credit counseling, including non-profit organizations, banks, credit cooperatives, and local churches.
A plan to settle your debts
Even if your debt is so large that you feel you will NEVER recover, there are alternatives before thinking about bankruptcy. Given the extent and nature of your debts, you may qualify for a debt settlement plan instead of going bankrupt.
Since bankruptcy will appear on your financial record and penalize you for many years, settling or repaying your debts is better.
“Consider the long-term consequences of bankruptcy on your financial record,” Lee said. “Filing for bankruptcy can have a negative impact on your creditworthiness for many years, and may make it more difficult for you to obtain loans or credit in the future. It is often better to try to settle or repay your debts rather than resorting to bankruptcy. By taking steps to address your debt issues in a responsible and timely manner, you can work towards improving your financial situation and avoiding the negative consequences of bankruptcy.”
Conclusion
Debt that becomes unmanageable has an impact on your daily life. When you reach the point where you miss opportunities and constantly think about those heavy balances, the moment has come to step in. Life is too brief and lengthy to be stuck with debilitating debt.
