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.
In this post, we will help you recognize the signs of too much debt and provide you with the information to help take control of your debt.
We live in a time of instant gratification. People want what they want, and they want it now. As a result, people are accumulating more household debt. In addition to climbing credit card debt, student loan debt is growing, and mortgage debt. The amount of debt is leaving consumers asking how much debt is too much. Keep reading to learn more about the impact of your mounting unsecured debt and how to reduce consumer debt.
Do you know what debt includes?
To understand how much debt is too much debt, you need to understand what debt is and the different types of debt. All loans and credit cards count toward your total debt. Consumer debt includes auto loans, mortgage debt, student loan debt, and credit card debt.
Mortgage debt and autos loans are secured debt. This means the debt has collateral which reduces the risk for the credit companies. The collateral on secured debt can be taken back by creditors to offset lost funds from unpaid debt. Unsecured debt includes not only credit cards but other debt like payday loans and personal loans. Some personal loans are secured by collateral as well.
How much debt is too much?
Determining how much debt is too much debt, you need to ask yourself some questions. It would be best if you also were honest about the information to understand your situation.
- How much debt load do you carry? (include credit card bills, car loans, mortgages, student loans, and any other debt payments you are responsible for.)
- What is your monthly income? Do you know your gross income and net income? Do you understand the difference between the two?
- What is your debt to income ratio?
- What is your credit score?
- What is your discretionary income?
- How long will it take you to pay your consumer debt?
- Do you struggle to make monthly debt payments (including mortgages, car loans, and student loans.)
- Are you over-drafting your bank account frequently?
- Is the balance on your credit card or other accounts increasing or decreasing?
- Have you applied for auto loans only to be turned down or presented with high interest rates?
- Are you receiving calls from a bill collector? (If you have fallen behind on your debt payments, these calls are likely mounting.)
Armed with the answers to these questions, you can now look at three specific components to determine if your credit debt is in danger of being excessive or already exceeded.
Debt to income ratio
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?
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 off 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 more straightforward 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 and your credit limits
Debt to credit limit is another good indicator, especially when it comes to revolving credit accounts. 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 in 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 a 33% debt to credit limit ratio, you may be viewed as having excessive debt. Of course, some variables can affect this. 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 need to request higher credit limits from your creditors.”
Debt and your monthly budget
DTI and debt to credit limit are great rules of thumb and used by credit scoring agencies. However, it’s more important to consider your debt in relation to your monthly budget.
Regardless of your DTI ratio or credit utilization, if your debt prevents you from saving or causing your budget to fall into the red, you have excessive debt.
To figure this out, you first have to make a monthly budget to see what you earn and what you are spending.
You have excessive debt. What can you do?
If you have answered the question “how much debt is too much” with a resounding “yes,” then keep reading. There are options that do not include filing for bankruptcy.
Reduce your debt load
A little disciple and a proven strategy can help people balance their credit situation and reduce how much debt they are trying to manage.
What debt strategies can I do on my own?
Here are a few strategies to employ on your own. You can work these strategies without involving a third party.
- Make more money. Indeed, we all want to make more money but to pay off too much debt. You may need to get a second job or another side hustle. Apply the additional funds to existing debt.
- Sell your stuff. Most of us have stuff, probably bought on a credit card, taking up space in our home. Sell items you are not using to pay down credit card bills and other debts.
- Avalanche method. Pay the minimum on all your accounts and as much as you can on the bill with the highest interest rate. Continue until all the bills are paid in full. This is the best method to minimize interest payments.
- Snowball method. Pay the minimum on all your accounts and as much as you can on your smallest account. Rinse and repeat until all debts are paid. Some people find it easier to stick to this method because it provides more frequent small wins that act as psychological boosts every time you pay off an account.
If you have an auto loan, student loan, or mortgage, you can investigate refinancing to reduce your payments. Refinance may also reduce your interest rate. Approval will be contingent on creditworthiness, monthly income, and your credit utilization ratio.
Keep reading to learn about other options to reduce your debt.
If you’re having trouble keeping up with all of your various monthly payments, working with credit counselors might help you pay down your debt in a more organized manner.
If you decide to consolidate your debt with a credit counseling agency’s help, you can combine all of your debt into one monthly payment. Once you find an agency to work with, you sign a contract granting them permission to act on your behalf to negotiate with your creditor to resolve your debt.
Some of the agencies are non-profits 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. 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. In some cases, they may be able to have interest charges reduced once repayment has begun.
Instead of paying all your debt individually on your own, you’ll develop a plan to pay off your debt with the debt relief organization. That plan will often include a single payment you must make to them, which they will then redistribute to your credit card or loan balance 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 a lower interest rate may be your best option. A debt consolidation loan will require you to qualify and result in an inquiry on your credit. Excessive credit utilization ratio or unstable income can disqualify you from this 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 credit card balances 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.
What does it all mean?
You have used your income, expenses, and debt to determine your debt to income ratio (DTI ratio). You have spoken with credit counselors or determined your own financial health. Now you have to take action.
I have bad credit. What can I do?
Your credit history has an impact on your life. If you have read this article and realize you have too much debt, start today to fix your situation. It will take time to rebuild your credit, but you can start taking steps to move in the right direction.
Your credit determines much more than your interest rate. Your credit impacts loan amount and down payment.
Set your benchmark
First, set a benchmark. You need to know what you are trying to achieve in your finances. This will help you keep focus as you make adjustments to your debt balance.
Next, start trimming expenses. Most of us have unnecessary expenses we can reduce if we try. Entertainment expenses are often the first area where we need to cut the fat.
Food expenses, on the other hand, are one of our largest daily expenses. Consider ways of cutting food and household expenses. Curbing daily coffees and eating out can produce significant savings.
Increase your income
We all want to increase our income. Before we worry about increasing our income to buy more stuff, we need to learn how to manage our income. When setting your financial goals, you want to develop a budget that has you living within your monthly income and allows for banking money in savings.
Increasing your immediate income will help improve your debt to income ratio. You can do this by securing a side gig, a part-time job, or even pursuing a raise or advancement at work.
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.
Andrew is the managing editor for SuperMoney and a certified personal finance counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.