Perceptions as to how much debt is too much debt vary, but financial experts in the credit industry have developed standards to help you determine if you are carrying too much debt. These standards can help you decide if you need to do something about your financial situation.
Consider the ratio of your debt to your income.
If you compare the amount of money you bring in (your income) to your debt (what you must pay out), you can get a pretty good picture of your financial situation. When evaluating a potential lender, banks and mortgage brokers consider debt-income ratios. You can calculate your debt-income ratio easily.
Take a list of your expenses accrued each month. (You can do this for a year, if you want to calculate your debt-income ration for the year. This model will focus on dent-income ration per month.) Prorate any expenses that hit once or twice a year like insurance or home owner’s association dues (you can do this by dividing the amount charged by the number of months the payment covers.) When figuring out your monthly credit card debt, you’ll want to calculate out the average debt over the past year by adding up statements and dividing by twelve. Eventually you’ll have a list like this:
Monthly Debt
Creditor Monthly amount owed Total owed
Rent/mortgage payment $2,000
Car loan $500 $16,000
Master Card $600 $3,000
Department Store Card $50 $250
Totals $3,150 $19,250
Of course your list is going to be much longer and more detailed than this one. Include all your monthly expenses. Just writing out this list will be an eye opener, as you’ll discover more and more expenses as you go. Sometimes just writing this out will highlight expenses you’ll decide to cut right then and there.
Next you’ll want to calculate your monthly income before taxes are taken out. You can do this by multiplying your paycheck by two (if you get paid every other week). Include extra incomes such as alimony, child support, social security or money from trust funds. If you work overtime regularly, make sure you factor that in. Soon you’ll have a list like this:
Monthly Income
Monthly salary $6,000
Social Security $235
Investment income $120
Regular Overtime $100
Total monthly income $6,555
Divide your monthly debt by your monthly income – in the example above that’s $3,150 divided by $6,555. The answer is your debt-income ratio. Find the percentage by moving the decimal point two places to the right.
Example $3,150 divided by $6,555 equals .4805492
When I move the decimal point and round down, I get 48%.
The example person’s debt-income ratio is 48%.
Now figure out your debt-income ratio.
What do the numbers mean?
It’s generally accepted that the following percentages fall into the following categories:
Under 36% = A - Healthy debt-income ratio
37%-42% = B – While still healthy, some loans may be tough to get.
43%-50%= C – Risky – You are charged higher rates.
Over 50%=D/F – Unhealthy – You definitely need help with your debt management.
Calculate your debt-income ratio and decide if you need help getting your debt under control.
