How Much Debt Is Too Much?

Nov 22, 2023 By Susan Kelly

Your goal is for your credit score to be as minimal as you can so you can be financially flexible in emergencies and for your future goals. If you're struggling to make each month's payments, you're most likely exceeding your debt capacity. What's the best way to determine how much debt is too much? The Consumer Financial Protection Bureau recommends keeping your ratio of debt to income less than 43 percent. In the statistics, those with debts exceeding 43 percent usually have trouble paying their monthly bills. One of the highest percentages you could attain and still get a qualified mortgage is 43 percent. If you plan to buy the house you've always wanted and your monthly mortgage payment will increase your debt to 43 percent, it is recommended to lower your debt before beginning your search for a home.

The 28/36 Rule

A good guideline to determine an acceptable debt burden can be the rule of 28/36. Based on this rule, families are advised to spend not less than 28% of total income on house-related expenses. This includes mortgage payments and homeowner's insurance, taxes on property, and condo/POA costs. In addition, households shouldn't spend more than 36% of their total services on debt, i.e., home expenses and other debts like credit cards and car loans.

Therefore, if you earn $50,000 annually and adhere to the rule of 28/36, your home expenses shouldn't be more than $14,000 per year or 1167 dollars per month. Other personal debt servicing obligations should not exceed $4,000 per year or $333 per month. In addition, assuming you obtain a fixed-rate mortgage for 30 years with interest at 4%, your monthly mortgage payments exceed $900 (leaving $267 (or $1,167 less $900 each month for the cost of insurance, taxes on property, and other home expenses). The maximum amount of mortgage debt you can take on is $188,500.

Suppose you're in the lucky position of not having credit card debt and no other debts and are considering buying a brand new car to take you to work. In that case, you could avail a loan for your car of approximately $17,500 (assuming that you pay 5 percent on the loan, which is repayable over five years). In summary, at a monthly income of $50,000 per year, or $4,167 per month, an acceptable amount of debt is less than the maximum limit of $188,500 for mortgage debt and $17,500 for another personal loan (a car loan in this case).

Gross Income vs. Net Income

Be aware that financial institutions use gross income when calculating debt ratios because net income or take-home earnings are different from one place to another, based on the income tax and other deductions. Your spending habits must be determined by the amount you take home, but this is the sum you will get after taxes and deductions.

Thus, assuming that taxes and deductions decrease the gross income by 25 percent in the previous scenario in the above example, you'll have $37,500, or $3,125 per month. This means you could allot $10,500 or $875 per month to household debt and $250 for other debts to a total debt that is $1125 per month, or $13,500 annually.

Naturally, the above debt burdens are based on the current rate of interest, which are near historical lows. A rise in interest rates on personal and mortgage loans will reduce the amount of debt that could be serviced as interest costs will take more of the monthly loan payment amounts.

Make the Repayment of Your Debt Easier To Manage

If you're struggling to pay off debt, there are ways to reduce the burden, such as refinancing your student loans, obtaining a debt consolidation loan, or using a credit card that allows balance transfers. A credit card for balance transfers will help you pay off the balances on your credit cards quicker by offering you an introductory interest-free period. It is the U.S. Bank Visa(r) Platinum Card offers 0% APR for the first 20 billing cycles of the balance transfer (and purchases), which means you'll have more than an entire period of one year to repay credit card debt without accruing additional charges (after, 15.24% - 25.24% variable APR). The introductory APR of 0% is available for balance transfers 60 days after account opening.

If you are looking for an account that allows balance transfers and provides rewards, the Citi(r) Double Cash card has zero APR in the initial 18-month period of the balance transfer (after 14.74% - 24.74% variable APR). Balance transfer transactions must be completed within the first four months after the account's opening. Cardholders can also enjoy earning cashback at 2 with 1% cashback on all eligible purchases and another 1% once they have paid the credit card charge.

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