How Much Debt Is Too Much?

There’s a lid on the amount of debt you can comfortably take on, generally tied to your income. Too much, and you’ll quickly find yourself in a bind. Here’s how to land on your sweet spot.

Some food for thought:

As of September of this year, the average amount of student loan debt was $29,939; for credit card debt, that number was $6,513. And as for home mortgage loans? $174,137 per household.

Depending on how your finances compare to the above figures — average, above average, or (and I hope this is the case) below average — you may be wondering, “Is this too much debt?”

Generally speaking, the less debt you have, the better. The money you’re now putting toward your credit cards or other debts could be used for retirement savings, an emergency fund or your child’s education. Still, some debt isn’t bad. In fact, unless you paid for your house and car in cash, a little bit of debt is unavoidable.

And there is, for the record, good debt. It gets you something important – that roof over your head, the car you drive back and forth to work and a college education. You can usually discern it from bad debt (the kind that gets you things you don’t actually need) because the interest rate will be lower and often tax deductible.

The key is to consider your debt-to-income ratio — that is, the percentage of your income that you have in debt.

As a general rule, your total debts (excluding mortgage) should be no more than 10 percent to 15 percent of your take-home pay (meaning, after you take out taxes and the like). If you’re not likely to incur any additional debt or unexpected expenses, you may be able to handle upward of 20 percent. Including your mortgage, your debt level should exceed no more than 36 percent of your take-home pay.

Why 36 percent? I didn’t pull that number out of a hat, I promise. Your debt-to-income ratio (DTI) is actually a pretty important number — sometimes it’s as important as your credit score. Lenders look at the ratio when trying to decide if they should lend you money or extend credit. A DTI of 36 or lower shows that you have a good balance between your debt and income and that — this is what is most important to lenders — you can handle your monthly loan payments.

You can calculate your DTI with a pen and paper (or, for the mathematically averse, a calculator). First, add up all of your monthly debt obligations: your mortgage, home equity loan payments, car loans, student loans, the minimum monthly payments on your credit cards, and any other loans you may have. Divide this sum by your gross monthly income, and voila — you’ll have your DTI.

If your debt load is higher than 36 percent of your monthly gross income, now is the time to consider paying down the debt if you’re not already doing so. Cut back on your spending or look for ways to reduce your expenses. With mortgage rates hitting record lows recently (the 30-year fixed-rate mortgage fell to 3.94% the week that ended on October 6), the first thing you should do is consider refinancing. And don’t stop with your house — you can refinance your auto loan to a lower rate, too, and it only takes about 15 minutes.

And even if your debt load is low, remember: there may be better ways to use that money. My advice? No matter how much debt you’re carrying right now, pay it down — and then once it’s gone, take those payments and start directing them towards your savings.

Jean Chatzky

Jean Chatzky