Do I Have Too Much Debt?

Most people have some level of debt, which may include a combination of mortgages, student loans, personal loans and credit card bills. However, if you have too much it can lead to all sorts of issues

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For American households, debt has become a way of life and in some of those houses, the figures are staggering.

Household debt (mortgage + home equity loans + credit cards + student loans + auto loans) in the United States reached $12.58 trillion at the end of 2016, an astonishing rise of $460 billion for the year. The typical American household carries an average debt of $134,643.

Whether it’s mortgages ($176,222 average debt), student loans ($49,905), auto loans ($28,948) or credit card debt ($16,748), money issues are rampant through every age group.

America’s median income has risen 28% since 2003, but the cost of living has increased 30% during that span. Meanwhile, medical costs are up by 57%, while food and beverage prices have risen 36%.

Ric Edelman, a syndicated radio host who has written eight books on personal finance, said at least part of the American debt plight can be blamed on a lack of financial education.

“Once you show people how money works, they almost instantaneously change their behaviors,” Edelman said. “There are a few people who are spendthrifts, who are psychologically in a place where they spend their money and can’t control themselves, but overall, people who spend money poorly simply don’t know what they’re doing is bad.”

How Much Debt Is Too Much?

There are common fixed expenses for nearly every American household that can’t be avoided. It’s impossible to avoid mortgage/rent; auto; credit cards and, in many cases, student loans.

The question that should be answered is what the spending limit should be in each area? Here are some guidelines from financial experts on how much to spend in these areas.

Most mortgages fall in the range of 31% to 36% of total income, including principal, interest, taxes, insurance and association fees. In some cases, usually in larger cities, it can push upward of 45% to 50%.

Those limits might need adjustment in times when regular pay raises can’t be counted on. Plus, past generations paid less for health care and college. Due to shorter lifespans and greater pensions, there wasn’t as much pressure to save for retirement.

So, what is reasonable? By capping housing costs at 25% of your income, it will give you flexibility in other areas. It should also allow you to have the house paid off by retirement age. It’s a huge advantage to choose a 15-year mortgage and stick with it, but reality for most people is that the lower monthly payment of a 30-year mortgage is more comfortable.

When it comes to student loans, ideally you won’t borrow more than you expect to make during your first year out of school. Parents shouldn’t borrow at all to pay for a child’s education because it will interfere with retirement savings. Aim for 10% of your gross income to go toward student loans and try to pay them off as soon as possible.

Automobiles are not a good investment. Car payments should be no more than 5% to 10% of gross monthly income. Shoot for a four-year loan and a 20% down payment to maximize your flexibility.

Credit cards always are the area of most concern. The smartest goal is to shoot for zero credit cards.

Zero? OK, make it one credit card … and for emergency use only!

Your financial life is much more manageable when you use a credit card to finance unexpected circumstances you really can’t afford, like an automobile repair or home repair or maybe a medical emergency. Credit cards become a nuisance when you use them to pay for anything and everything from groceries to gas to utility bills, clothes shopping, entertainment and so on.

If you’re going to use a credit card, do it with discipline, reasonable spending expectations and the goal of paying off the debt every month. At the very least, make more than the minimum payment and don’t saddle yourself with more unneeded purchases.

“Modern life can be difficult,” Houston financial advisor Joseph Birkofer said. “People choose debt instead of going without, so the problem keeps growing. At some point, I think you do have to say that enough is enough.”

Debt To Income Ratio

One of the methods lenders use to determine if you have too much debt is by pouring your regular expenses and income into a formula and coming out with something called a debt-to-income ratio or DTI.

Your DTI is expressed as a percentage through this formula: recurring monthly debt ÷ gross monthly income = debt-to-income ratio.

There are two ways to determine your debt ratio, one involving your mortgage payment, one leaving it out. The one involving mortgage (or rent) payments is the one most often used by lenders in deciding whether to approve a loan so we’ll begin there.

Add up all your monthly debt payments, things like credit card bills, auto loans, student loans, personal loans and the rent/mortgage payment. Divide that figure by your gross monthly take-home income, which is your income before taxes and other deductions are taken out.

So, for example, let’s say your total monthly debt payments equal $3,000 and your gross monthly income is $6,000. The math for that is 3,000 ÷ 6,000 = .50 or 50%. That is considered extremely high. You have more debt than you can handle.

When mortgage/rent is included in the equation, lenders like to see a 35% or less DTI ratio. The housing industry will make you a loan with a DTI as high as 43%, but your interest rate will reflect the increase risk to the lender and be very high.

The other method for DTI – seldom used – is the same formula, minus your mortgage/rent payment. The resulting figure should be 10% or lower. That means your debts should account for 10% (or less) of your income. If it’s a larger figure, bells should be clanging in your head.

Potential fixes? The simple answer is to a) cut expenses; and b) increase income. Unfortunately, it may take a while to adopt either habit.

“These are habits that are best established early in your life, but I see young people as being a very vulnerable group,” said George Washington University professor Annamaria Lusardi, who is considered one of the world’s foremost experts on personal debt. “We have a $1.3 trillion student loan debt in this country and we also have a huge part of the population that doesn’t grasp the concept of compound interest.

“These young people start their adult life in debt. They are highly leveraged. It leads to mismanagement of their finances, which perpetuates the debt problem we have today.’’

Here are some tell-tale examples that your debts have climbed too high:

  • Your consumer debts (credit cards, medical bills, personal loans) total half or more of your income.
  • Creditors are calling to collect payments.
  • You’re making only minimum payments on monthly credit card bills.
  • Your credit cards are maxed out.
  • You have been rejected for new lines of credit. Either you have too much debt or your recent credit history is damaged. Or both.
  • You don’t have an emergency fund. Financial advisors universally recommend liquid funds equivalent to three to six months of your income in case of a financial emergency, such as losing your job or unexpected medical bills.
  • Your bank account is typically at (or below) $0.
  • After paying bills, there’s no money for basic extras, such as seeing a movie or ordering food.
  • You have taken advances on your paychecks.
  • You are paying bills late because there isn’t enough money in your account to cover those costs.
  • You open a new credit card account to help pay off another credit card or to pay typical monthly bills. Bad strategy. The goal is to REDUCE the total amount of debt, not add to it.

Seeking Help

People like to believe they can control their finances, but sometimes the situation gets overwhelming and they need to reach out for help. There are some quick fixes that seem like they would provide relief, but all they do is dig you a deeper hole.

Things like payday loans; car title loans, rent-to-own items and loans with “no credit check” should be avoided at all costs. Each one of those will make you situation worse, not better.

If you can’t turn the situation around yourself, consider contacting a nonprofit credit counseling agency. The credit counselors will work with companies to reduce the interest rate on your credit cards; they will help sort out your spending issues; help you develop a budget and put you on an affordable payment schedule.

The process – known as debt management – usually takes 3-5 years, but you are debt free when it’s over.

How do you know it’s time to call a nonprofit credit counseling agency?

  • If you’re adding (not subtracting) debt every month.
  • If you’re living paycheck to paycheck.
  • If marriage doubles your problem – i.e. you suddenly owe twice as much because your new husband or wife brings debt into the union.
  • Your net worth is less than zero.
  • You don’t answer the phone because it might be a bill collector. At this stage, you’re probably losing sleep over your finances. It’s a sign your debt is officially out of control.
  • Your savings have been drained.
  • You have turned to drugs or alcohol.
  • You hide spending habits from loved ones.

Understanding Debt

To most people, debt represents another four-letter word they rather not use.

Some people are so averse to it that they won’t even consider a car loan because of the risk it creates. They pay cash for everything and never carry a balance on a credit card, if they even have a credit card!

That is one extreme.

The opposite would be the risk-takers, people who love to use other people’s money to their advantage. Occasionally, it can result in big losses, but it’s also a way to make big gains.

To be sure, most Americans reside somewhere near the middle. We are cognizant that debt sometimes is used to build wealth, but aware it also can destroy a comfortable lifestyle.

It’s all in how you view the world and how you take advantage of opportunities.

  • To some, student loans are a bridge to higher education, a chance to dramatically boost earning power. To others, student loans are an anvil, requiring a lifetime of payments that delay (or prevent) the purchase of a home, having a family or saving for retirement.
  • To some, mortgages build equity for the future, while providing a place to call home. To others, mortgages are a huge debt that could end up in foreclosure.
  • To some, auto loans allow us to purchase safe, reliable transportation. To others, auto loans add a rapidly depreciating asset to our pile of debt.
  • To some, business loans can help us launch or expand a company. To others, business loans jeopardize the enterprise, zap the company’s wealth and potentially put some people out of work.

Sometimes, taking on debt is the difference between recognizing opportunity and being too scared to move forward.

Learning Discipline

Avoiding too much debt really revolves around personal responsibility. Remember, lenders are usually willing to give you far more money than you can comfortably repay. Setting limits is up to you.

A good place to start is the 50/30/20 guideline advocated by U.S. Sen. Elizabeth Warren, a bankruptcy expert, and her daughter Amelia Warren Tyagi in their book, “All Your Worth.’’

The 50 stands for limiting your “must have’’ expenses — shelter, utilities, food, transportation, insurance, child care and minimum loan payments — to 50% of your after-tax income. And here’s another gauge for debt. If a new debt payment keeps you under the 50% mark, you can probably afford it. This can be a tough one in major cities, where typically nearly half of your income is needed for the mortgage or rent.

The 30 is for your wants. Use 30% of your income for “luxuries,’’ such as eating out and vacations.

The 20 is the remaining 20% of income that should be used for saving and paying down debt.

It can all be very daunting, trying to stay in these ranges, trying to save for the future while paying off the past.

But it can also give you a guide to evaluate your debt on all levels.

About The Author

Bill Fay

Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].


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