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How Much Debt Is Too Much?

7-Minute Read

Getting in over our heads with debt is one of the easiest traps to fall into. Whatever your situation, you’re not alone. Right now, many Americans are shouldering an inordinate and increasing amount of debt.

If you’ve ever struggled with debt, you know all too well how all-consuming it can become. So let’s find a way to avoid that feeling by learning how to keep track of your debt and knowing when you need to just say no.

How Much Debt Are Americans In?

According to the Federal Reserve Bank of NY, total household debt in the U.S. rose by $87 billion (0.6 percent) to $14.35 trillion in the third quarter of 2020, more than offsetting the decline seen in Q2, when there were sharp increases in unemployment and strict lockdowns in place.

This means that American households are holding an average of $145,000 in debt, with a median debt that amounts to around $65,000.

Is That Amount Of Debt Bad?

It’s not all bad. Let’s talk about why.

What Is Good Debt?

That debt includes mortgages, the largest chunk of debt owed by Americans. In general, mortgages are considered "good debt," or the type of debt that offers tax advantages, fulfills a need rather than a want, and supports your ownership of an asset that increases, or appreciates, in value.

Of course, if your house is grander than the income that pays for it, you may be "house poor," which means there’s not enough left over after your monthly mortgage payment to square away your other expenses.

Other types of good debt include student loans, business loans and – to the extent cars are  necessary for reliable transportation – auto loans.

What Is Bad Debt?

Essentially, any accruing payments that you can’t afford.

Taking "good debt" loans out of the equation still leaves Americans with a total credit card debt of $807 billion, and a total revolving home equity debt of $362 billion. If you’re struggling to repay your credit, you know the sinking feeling of looking at a balance that’s growing, even though you haven’t made any new purchases.

Unfortunately, as unemployment is rising and many are in a precarious financial situation because of the pandemic, more and more Americans are jostling debt between credit cards to pay for basic necessities.

How Much Credit Card Debt Is Too Much?

Credit card debt is a problem for many of us. It’s so disheartening to see your balance rise even when you’re making minimum payments and cutting back on your purchases. Here are some common red flags indicating that your credit card debt is out of control:

  • You can only make a minimum payment and you struggle to make it on time.
  • You are relying on credit cards to pay for essentials, but you aren’t able to pay those charges off when the bill comes due.
  • You are shuffling credit balances from one card to another.

If this sounds familiar, you might want to consider a debt consolidation loan so that you can make payments more manageable, by combining several payments into one monthly payment at a lower interest rate.

Learn more about other ways to get out of credit card debt.

How Much Debt Do I Have?

The easiest way to answer this question is to calculate the income percent required to make your monthly debt payments. This is known as your debt-to-income ratio (DTI), and it is an important factor in evaluating your financial stability.

How To Calculate Your Debt-To-Income Ratio (DTI)

Your debt-to-income ratio compares how much money you owe per month to how much money you earn per month. Figuring out your debt-to-income ratio is not as difficult as it may seem. Use the information below to calculate what your DTI is.

Step 1: Add Up Your Fixed Monthly Debts

These expenses may include:

  • Monthly rent or house payment
  • Minimum monthly credit card payments
  • Student, auto and other monthly loan payments
  • Monthly alimony or child support payments
  • Other debt

Some other payments, like groceries, utilities, gas and taxes are typically not included in the DTI calculation, but remember to take them into account when you're planning your monthly budget.

Step 2: Divide By Your Gross Income (Income Before Taxes)

Sources of income can include:

  • Wages
  • Business profits
  • Salaries
  • Tips and bonuses
  • Pension
  • Social security
  • Child support and alimony

Step 3: Convert Your Answer To A Percentage

The final result is your debt-to-income ratio.

Consider this example. Let’s assume you pay rent at a monthly rate of $1,500, a car payment of $500 and a minimum credit card payment of $150. Let’s also assume that you have a gross monthly income of $5,000. Your debt-to-income ratio is $2,150 divided by $5,000, which equals 43%.

What Is The Significance Of DTI?

According to the Consumer Financial Protection Bureau, a prospective borrower’s DTI is an important factor in determining whether a borrower will have problems meeting their monthly payments. For this reason, since the 2008 Financial Crisis, mortgage lenders have been required to deny loans to prospective mortgage borrowers with a DTI greater than 43%.

Some government-backed mortgages allow low-income borrowers to have DTIs in the 50% range, but only with very stable income and excellent credit scores.

How Much Debt Should I Have? Analyzing Your DTI

Most financial experts will tell you that a DTI no greater than 35% is ideal, with no more than 28% going toward housing expenses. At 36%, borrowers will start feeling the pinch of increasing debt, and while they will still qualify for mortgages, they will begin to pay higher interest rates. At 43%, as discussed above, you’ll have trouble getting any mortgage. At 50%, you are in serious risk of defaulting on your mortgage.

The Emotional Weight Of Carrying Debt

If your DTI is low, that’s great! Going through this exercise should give you a sense of confidence in your financial decision-making when it comes to taking on debt. As long as you keep your DTI in that range by living within your means, you may feel free to continue on your course.

If your DTI is high, don’t panic and don’t beat yourself up. In many large, expensive cities, it is nearly impossible to keep your DTI low in the early stages of your career because of the exorbitant cost of housing. It remains to be seen whether careers can be advanced remotely in ways comparable to how careers have traditionally been built by creatives living and working in proximity to one another. It’s possible that advances in remote work will allow you to move to a more affordable location soon.

Other Warning Signs That Your Debts Are Out Of Control

If you’re the type of person who handles difficult situations by ignoring them, or you have lost track of your finances and the idea of calculating your DTI is too overwhelming at the moment, there are other ways to know that you’re carrying too much debt.

If you are in any of these situations, it might be time to get some help:

  • You rarely have money in the days before payday, and you are cobbling together change to make it until your check is deposited.
  • You use your credit card to make routine purchases and you are not paying the entire balance when you get your statement.
  • Your debt isn’t going down, and in some cases it’s going up, because you’re only able to make minimum payments on your credit card.
  • Close to half of your monthly income goes to debt, and that amount seems to be increasing.
  • You’re unable to participate in your employer’s retirement plan.
  • You’re unable to save any money for an emergency fund.

If You Have Too Much Debt, Help Is Available

If you find yourself saddled with debt, talk it out with someone you trust who can help you create a spreadsheet of your debts and expenses and create a budget. There are also no- and low-cost credit counseling services available through a variety of programs.

It’s very possible that the situation isn’t as dire as you think, and that getting a handle on your financial big picture will give you peace of mind as well as an actionable plan. Learn more about improving your finances with Rocket Loans.

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