Gather Your Income Info
Comparing your debt to your income gives you a better idea of whether you can afford your debt load. Start by gathering your income info. Most credit card companies and lenders consider your monthly gross, or before-tax, income when they’re qualifying you for a credit card or loan. Use your paystubs, or invoice receipts if you’re a contractor or self-employed, to figure out how much you bring in each month.
Calculate Your Debt-to-Income Ratio
Your debt-to-income ratio allows you to quickly compare your monthly debt payments to your monthly income. You can calculate your own ratio by dividing your gross monthly income by your monthly debt payments, which could include:
Mortgage or rentAuto loansStudent loansCredit cardsPersonal loans
Your debt-to-income ratio includes both good and bad debt. “Good debt” is considered debt you can repay and has a low interest rate that you use to buy something that increases in value (a mortgage, for example, or student loans). “Bad debt,” on the other hand, is high-interest debt you can’t repay that’s used for things that don’t necessarily increase in value (credit cards, for example). Having a high percentage of bad debt, which includes credit card debt, can indicate that you have more debt than you can afford.
How Much Debt Is Too Much?
Another way of looking at your debt-to-income ratio is to divide your total debt, and not just your monthly payments, by your total annual income. Economists use this method to gauge economic growth, but it can also give some insight into your total indebtedness. The average consumer has $90,460 in debt, including mortgages, and a personal income of $50,413, according to figures from Experian and the U.S. Census. Using those 2019 figures, the aggregate DTI ratio for the entire United States was 1.79. You can check out state-by-state (and even county-by-county) data on U.S. consumer debt via the Federal Reserve’s Household Debt Overview. Your monthly non-debt expenses can affect what you can truly afford and the calculations, while helpful, don’t always give you a concrete answer. You may have too much credit card debt if you can’t make progress on your existing debt or can’t save. Signs of these financial trouble spots include:
You can only afford the minimum payments on your debtYour credit card balances are above 30% of the credit limitYou’re living paycheck to paycheckYou can’t afford to build an emergency fund
Next Steps and More Resources
When you’ve decided you’re ready to pay off your debt, the next step is figuring out a strategy that will work for you. There’s more than one way to approach debt payoff and some are better than others. Before that, here are a few more resources on figuring out whether your current debt load is manageable:
Learn more about the debt-to-income ratio and why knowing it is important to your finances. After you’ve calculated your DTI, take steps to lower tour debt-to-income ratio if it’s higher than you’d like it to be. Follow the 20/10 rule to keep debt affordable: Aim to keep monthly consumer debt payments under 10% of monthly income and keep total consumer debt under 20% of annual income.
