Debt. It is a four-letter word that can put a lot of pressure on people. However, it is essential to understand that debt can be effective in achieving your financial objectives. And while a small amount of debt will not harm, too much debt slowly turns us into a nervous, anxious, struggling individual. So, the question becomes: What exactly constitutes as “too much debt”? In fact, the answer here is that there is no exact particular answer. That really depends on personal finance.
This blog will discuss how to assess your debt and whether it is too much or not in straightforward strategies.
Check Your Debt-to-Income (DTI) Ratio
It’s not just the total number of debt you have that defines the credit risk situation. It’s also about how much of your income goes towards paying it off each month. It is where your debt-to-income ratio comes in.
To calculate it:
- Determine the total of your minimum monthly debt payments: student loans, mortgage/rent, auto loans, credit card minimums, and other regular bills.
- Find the ratio by dividing this total by your gross monthly income.
- Multiply the result by 100 to find your debt-to-income (DTI) ratio.
It shows lenders and, more importantly, yourself, how much of your income is used in the payment of debts and if one is capable of managing more debts. Typically, the DTI ratio is desired to be below 36%, while going above 43% may be indicative of stress on financials.
When the DTI ratio ranges between 36-41 %, you will be able to show that the debt is easily repayable given steady income and good credit score, thus improving your propensity towards funding.
If you’re looking for a loan with high debt, like a mortgage, specialized options like FHA, VA, or asset-based loans, which are designed to accommodate higher DTIs, can be helpful.
Evaluate Your Credit Utilization Ratio
While your DTI ratio looks at your overall debt burden, your credit utilization ratio focuses specifically on your credit card debt. It measures how much of your available credit limit you’re using. Credit bureaus track this ratio because it can indicate potential trouble managing credit card debt.
Here’s how to calculate:
- Add up the total balances on all your credit cards.
- Divide this sum by the total credit limit across all your cards.
- Multiply the result by 100 to get the percentage.
Generally, a credit utilization ratio below 30% is considered suitable for your credit score. The lower the ratio, the better. Ideally, it would help if you aimed to pay your credit cards in full each month to keep your net utilization ratio at 0%. A high credit utilization ratio, even if you manage to pay your bills on time, can negatively impact your credit score. It is because it suggests a potential for overspending or difficulty managing credit.
Warning Signs of Too Much Debt
Here are some signs you might be carrying more debt than you can healthily manage:
- Debt is affecting your mental and physical well-being: Stress and anxiety from debt can result in sleep disturbances, elevated blood pressure, and other health complications.
- You’re only making minimum payments and not chipping away at the principal: Minimum payments can leave you stuck in debt for a long time.
Ideally, you should aim to pay more than the minimum to reduce your principal balance and become debt-free faster. You can explore different strategies like the debt snowball or avalanche method to prioritize settling off high-interest debts first.
Conclusion
Don’t worry if your debt is too high—there are still ways to get financed and manage your debt. One option is debt consolidation, which allows you to merge several debts into one loan with a reduced interest rate. Also, you can work with a credit counseling agency to establish a debt management plan and negotiate more favorable terms and fees with creditors.
If you want a loan with high debt, some lenders will still work with you, especially if you show a steady income and a good credit history. But don’t take on new debt just to improve your DTI ratio—instead, focus on managing and reducing your existing debt to improve your financial health.