How Much Debt Is Too Much?

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Having debt in America is common. In fact, Americans have accumulated $14.6 trillion in debt collectively. 

You may wonder how much debt is too much, asking yourself if you have too much debt.

Debt comes in all flavors, from credit card debt to auto loans to mortgages and many other ways you can owe money.

There is unsecured debt, which is when you owe money to someone and there’s no tangible asset attached to it. An example of unsecured debt is credit card debt.

There is also secured debt, where an asset backs the debt. For example, an auto loan is a type of secured debt as the lender can repossess the automobile if you stop making payments.

In this article, we’ll go over how much debt is too much and answer different questions about debt in general.

Let’s jump right in.

How Much Debt Is Too Much?

Having your debt as low as possible is best, as this allows you to be more financially secure. As you take on more and more debt, it becomes more challenging to meet your financial obligations as you have more money flowing out each month to cover these debts.

The Consumer Financial Protection Bureau recommends keeping your debt-to-income ratio (DTI) below 43%.

That means if you have a gross monthly income of $5,000, you would want to keep your total monthly debt payments at $2,150 or less, as this is 43% of your income.

If you find your DTI is above 43%, then you’ll want to consider paying down debt more aggressively, taking on less debt, and looking for ways to increase your income.

How Do You Calculate Your Debt-to-Income Ratio?

To calculate your Debt-to-Income ratio (DTI), first, add up all of your debts. These include things such as:

• Alimony
• Credit card minimum payments
• Child support
• Rent or mortgage payment
• Any personal loans, auto loans, student loans, and any other loan payments

You won’t include things such as your everyday living expenses such as your cable, internet, or phone bills. These expenses need to be paid but are not debts.

Next, divide your total debt payment by your gross monthly income. If your total debt owed is $1,000 and you make $4,000 per month, then your DTI is 25%.

How Can You Lower Your Debt-to-Income Ratio?

The two main ways to lower your DTI are lowering your total debt payment each month or increasing your monthly income.

Refinancing loans or consolidating debt are possible ways that you can lower your total debt payments, as you may pay a lower interest rate and bundle your payments into a single monthly payment.

Three examples of Increasing your income are taking on extra shifts at work, getting a raise, or picking up a side job.

If you have a high interest credit card with a large balance, you could consider transferring the balance to an introductory 0% APR card, though this is best done if you know you can pay off the balance before the 0% period expires.

Good Debt Definition

Good debt includes when you borrow money to invest in yourself or something that will make you more money in the future. Some examples of good debt include:

• A mortgage: You assume the house will increase in value over time.
• Student loans: The education you get from college will help you make significantly more money.
• Business loan: The business you founded will one day set you up for more money than you believe you’d make at a traditional job.

In short, good debt provides something of value to you later down the road.

Bad Debt Definition

Bad debt is debt that is used to buy things that depreciate or eventually go away. Swiping your credit card to buy a fancy meal, designer clothing, or video games are all examples of things that cause you to incur bad debt.

This is because there is no financial value to these things, and you’re spending money that you might not currently have.

Another type of bad debt is payday loans, which have notoriously high interest rates and can significantly harm your financial situation. This type of toxic debt is best avoided.

What’s the Difference Between Good Debt and Bad Debt?

The main difference between good debt and bad debt is that taking on good debt will eventually provide you more money in the future or an increase in net worth, whereas bad debt is used to purchase things that are consumed or that depreciate.

What Are Signs That You Have Too Much Debt?

Here are some warning signs that you may have too much debt or that your debt situation is getting out of control:

• You live paycheck to paycheck, and your credit card balance stays the same or increases.
• You always use your credit cards and have trouble paying them off.
• You don’t have an emergency fund and rely on your credit cards when unexpected expenses come up.
• You’re unable to invest for your future.
• Your net worth is negative.
• You use payday loans.
• Collection agencies keep calling you.

If any of these sounds like you, you might consider seeking a financial counselor to help you navigate your finances and improve your financial situation.

Does Debt Affect Your Credit Score?

Credit utilization affects your credit score, so your credit score can suffer if you’re running a high balance on your credit cards.

Read more about how to raise your credit score here.

If you’re using more than 30% of your available credit limit, your score might take a hit as lenders and creditors may feel that you’re overextended.

What To Do If You Have Too Much Debt?

You have some options if you have too much debt and are wondering what to do. Here are three:

Debt Consolidation Loan

A debt consolidation loan is a loan that you take out to pay off all of your other debts. You then have a single monthly payment at a single interest rate instead of many monthly payments at varying interest rates.

Debt consolidation loans typically have lower interest rates than credit cards, which means you may pay significantly less money towards interest as you pay it down. This, in turn, saves you money which can be tucked away for the future.

If you need a personal loan to consolidate debt, check your rate in minutes at Upstart.

Credit Counseling

A credit counselor can help you come up with a way to pay down your debt and live below your means. You can often find credit counselors that provide low-to-no-cost services at banks, credit unions, or churches.

Make sure you do your research when hiring a credit counselor and that you feel comfortable working with them.

Debt Settling Program

You might be able to get help from a debt settling program if you’re running out of options and don’t want to declare bankruptcy.

Bankruptcies stay on your credit report for many years, depending on the type you file, so finding another option might be best if you can do it.

Creditors aren’t required to settle debts with you, but it might not hurt to try.

Wrapping It Up

Too much debt can lead to financial stress, negatively impacting your day-to-day life. 

Keep an eye out for warning signs that you might be overextended, and work on paying your debts down when your debt levels start to rise.

Use tools like budgets and apps to help you track your spending and cut back so that you can avoid any surprises that may come up