Certain levels of debt may be manageable and may not put a major strain on your budget. On the other hand, having too much debt can cause an unhealthy financial life. Even if you can afford the monthly payments, your debt may still affect your ability to meet other financial and life goals. If you fear you might have too much debt, there’s a way to see exactly where you stand.
Do You Have Too Much Debt?
You might have already felt the effects of having too much debt. For example, you may have too much debt if you have to use your credit card to pay for ordinary expenses, you frequently run out of money before your next paycheck, or you don’t have enough money to build an emergency fund or save for retirement. These are signs that you’re spending too much of your income on debt payments. Rather than guessing, you can calculate your level of indebtedness relative to your income. One of the easiest ways to calculate your debt load is by figuring out your debt-to-income ratio. This number compares your monthly debt payments to your monthly income. You can calculate your debt-to-income ratio in two different ways. You can include all your debt or only your non-mortgage debt. Leaving out your mortgage allows you to measure only the amount of consumer debt you’re carrying. Carrying high amounts of consumer debt, like credit cards, personal loans, auto loans, and medical bills causes more financial problems if you fall behind. On the other hand, if you want a total picture of your debt, include all your debt including your mortgage.
Calculating Debt Overload
Let’s say you want to measure the amount of consumer debt you’re carrying. Simply total the amount you spend each month on credit cards and loans (not your mortgage), then divide that amount by your total monthly income. Multiply the result by 100 to get a percentage. The result is your debt-to-income ratio. For example, assume your monthly income is $3,000. Let’s also say you spend $300 on credit card payments and $450 on an auto loan. Your ratio calculation would be $750 / $3,000 = 0.25. Then multiply by 100 for a debt-income-ratio of 25%. In this example, you spend a quarter of your income on consumer debt. Consider it this way: for every $1 you earn, you’re spending 25 cents on debt, leaving you with 75 cents for savings, non-debt expenses, and other financial goals.
Understanding Your Total Debt
There will be times when you want to evaluate your total debt picture, particularly if you’re a homeowner. The debt-to-income ratio calculation is the same, the only difference is that you include all your monthly debt payments, including your mortgage. To calculate your total debt-to-income ratio, add up your total monthly debt expenses. This includes payments for credit cards, student loans, mortgage or rent, child support or alimony, and other loans or credit cards. Next total your monthly income, including take-home pay, alimony or child support, bonuses, or dividends. Divide your total debt payments by your total income (don’t forget to multiply by 100) for your debt-to-income ratio. If you determine that you have too much debt, you can put together a plan to lower your debt. Not only will that make your finances easier to manage, it will improve your credit too.
