In 1964, United States Supreme Court Justice Potter Stewart attempted to describe his threshold test for obscenity in Jacobellis v. Ohio, famously saying it was difficult to define, but “I know it when I see it.” People often think of excessive debt this way. They may not have a ready definition for what counts as excessive debt, but they know it when they see it.
However, excessive debt can be quantified, and here are some ways to go about doing just that.
Ian Atkins— an analyst and staff writer for Fit Small Business who has over nine years working in personal and small business finance– explains that there are three ways to think about what qualifies as excessive debt.
Debt in relation to your income
You can easily calculate your debt to income ratio (DTI) by adding up all of your monthly debt payments (including mortgage or rent) and dividing this number by your GROSS monthly income. So, what’s a good percentage to have for DTI?
Atkins says, “One rule of thumb is the max DTI allowable for qualified mortgages, and that’s 43%. Another way to think about it is the DTI that most unsecured lenders (credit cards, personal loans, etc) would consider acceptable, and that’s 33% So think of the max range lenders would be comfortable with between 33% – 43%. As you approach 43%+, lenders will start to feel you’re biting off more than you can chew.”
Christian Zimmerman, CEO and founder of Qoins, an app that helps you pay down debt with your spare change, agrees that DTI is a good way to gauge if you’re in over your head.
However, he suggests an even simpler way to think about it: “If you can’t make your monthly payments or you’re finding yourself going over your credit limit then you probably have too much debt.”
Debt in relation to your credit limits
Debt to credit limit is another good indicator, especially when it comes to revolving credit accounts, explains Atkins, adding, “Once your debt to credit limit ratio exceeds 33% on any account or in total, you can reasonably expect your credit score to start taking a hit as credit agencies are factoring a higher risk of potential default.”
Regardless of your DTI or credit utilization, if your debt is preventing you from saving or causing your budget to fall into the red, you have excessive debt
So, if you’re at 33% debt to credit limit ratio, you may be viewed as having excessive debt. Of course, there are variables that can affect this. Atkins says, “This isn’t a number that lives in a bubble. If your debt to credit limit ratio is high but your debt to income ratio is low, it may be that you simply need to request higher credit limits from your creditors.”
Debt in relation to your monthly budget
DTI and debt to credit limit are great rules of thumb and definitely used by creditors and credit scoring agencies. However, says Atkins, it’s most important to consider your debt in relation to your monthly budget.
“Regardless of your DTI or credit utilization, if your debt is preventing you from saving or causing your budget to fall into the red, you have excessive debt,” he says.
To figure this out, you first have to make a monthly budget to see what you actually earn and what you are spending.
You have excessive debt. What can you do?
If you’re having trouble keeping up with all of your various monthly payments, working with a credit counseling agency might help you pay down your debt in a more organized manner.
If you decide to consolidate your debt with the help of a credit counseling agency, you can combine all of your debt into one monthly payment. Once you find an agency to work with, you sign a contract granting an agency permission to act on your behalf to negotiate with creditors to resolve your debt.
Some of the agencies are nonprofits that charge non-fee rates, while others can be for-profit and include high fees.
Companies that offer credit counseling will sometimes offer debt consolidation programs. Atkins explains that while these companies do not actually consolidate the debt into one loan or refinance the debt to a lower rate, they may offer to manage your debt payments for you.
“Instead of paying all your creditors individually on your own, you’ll develop a plan to pay off creditors with the debt relief organization,” Atkins says. “That plan will often include a single payment you must make to them, which they will then redistribute to your creditors to achieve the goal of eliminating your debt in the most efficient way possible. It’s important to note that you’re paying back 100% of your debt.”
Debt consolidation loans
If you have good credit, consolidating all your loans into a more manageable loan with lower rates better terms may be your best option.
Another interesting option for borrowers with good or excellent credit is to apply for a 0% APR balance transfer credit card with a long introductory period. These cards allow you to transfer debt without paying interest for six to 21 months. In most cases, you will have to pay a balance transfer fee of 3% to 5% of the amount transferred but you can save thousands of dollars if you repay the loan within the 0% APR period.
If your credit is bad and you can’t afford to make monthly payments, it may be time to consider a debt settlement program. These programs negotiate with your creditors to reduce the amount you owe in exchange for a lump-sum payment. If successful, a debt settlement program can remove your debts for a fraction of what you owe. Your credit will take a hit, but if your credit score is already bad it may be worth considering.
Debt consolidation loans, credit cards, debt settlement programs, and credit counseling agencies can all help you resolve your debt problems. However, you need to compare fees and rates to determine which option is best for you.