dept ratio

 

If you have a credit card and other forms of debt, you may have asked yourself, “How much debt is too much?” It’s important to know this limit, but it varies widely from individual to individual. As many people in the U.S. suffer from vast amounts of debt that can seem nearly impossible to pull out of, this is an essential answer to know before you get yourself into any financial trouble.

How much debt you can reasonably have is going to depend on a few different factors: what type of debt it is (such as mortgage, car note, school loans, credit cards, etc.), how much you accumulate monthly and, most importantly, how much income you are bringing in. If you are not bringing in enough revenue to balance out your debt at least in part, you may be getting close to a dangerous limit.

You do have a way to figure out how close you are to your debt limit: the debt-to-income ratio.

Debt-to-income Ratio

expense and income

The easiest way to think how much debt you can reasonably carry is by using your debt-to-income ratio. To calculate this ratio, you need to first add all of your regular monthly payments, such as your mortgage or rent, car note and insurance, school loans, minimum credit card payments and so on. You also need to know the total of your monthly income, which can include gross salary, overtime, alimony and annual bonuses divided by 12. Divide the number of monthly payments by the total of your monthly income—this figure is your debt-to-income ratio.

Once you have this ratio figured, out, you’re going to need to see what exactly it means on another scale of numbers. If your ratio is 36 percent or less, you have a healthy debt load, regarding most people. As for what lenders are looking for, 30 percent is ideal. If you scored 37 to 42 percent, this number isn’t too bad, but you need to start paring debt soon before you run any financial risks. A ratio of 43 to 49 means that you are in trouble unless you take immediate action, and a score of 50 percent or more will require that you seek professional help to combat your debt issues aggressively.

When It Makes Sense to Go Into Debt

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Sometimes, taking on some debt makes sense; other times, it does not. For example, if you are investing in a home, which will provide future equity, or your college education, which can improve your chances of getting a better job in the future, these may be sensible instances in which you would take on debt. Where you might run into trouble is if you sign for a house that is too big with payments that are far too heavy for your income or a school with tuition that is far out of reach for the position you might find yourself in the future. You need to weigh the pros and cons of the debt carefully before making your decision.

Then comes the question of credit card debt. Some people suggest that you never get a credit card to protect yourself from the temptation of going into such debt. Others say that credit cards are good for building good credit and getting yourself through the tougher times. You need to be even more sense when it comes to credit card debt because this compounding interest is where a lot of people find themselves in financial trouble.

Always keep a sound mind about the state of your finances, particularly if you are carrying around any debt. If you’re questioning whether or not you have too much, figure out your debt-to-income ratio, and go from there. You’ll be glad you did once you have the answer to that nagging question—regardless of the outcome.