If you’re like most Americans, you have debt. For many of us, some debt is fine — even healthy when it accommodates a financial goal like owning a home or earning a degree. But how much debt is too much?
If your debt is causing you stress or sleepless nights, then it’s time to assess what you owe.
Situations vary, but some common warning signs of problem debt include:
- Your debt balance is not going down despite regular payments
- You’re living paycheck to paycheck, with no money at the end of the month
- You’re not contributing to an employer-sponsored retirement plan because you need the money
- You’re unable to build an emergency fund of at least $500 to buffer against financial shocks
- You’re using credit cards for cash advances
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“There is no one rule for debt,” says David Nash, a certified financial planner at Magister Wealth in San Antonio, Texas. However, he adds, “If your debt level is increasing as a percentage of your income, that indicates some tougher tradeoffs need to be considered.”
Perhaps as important is how you feel financially. If your debt is causing you stress or sleepless nights, then it’s likely time to assess what you owe and pay off your debt.
Distinguish between good debt and bad debt
Over three-quarters (77.1%) of American families have debt, according to a September 2017 report from the Federal Reserve. Families with debt had a median balance of $59,800. The report breaks down the percentage of families that carry different types of debt, shown in the table below.
Median household debt by age
|All households||% with debt||Median balance|
|Other installment loans||11.3%||$3,400|
|Under 35||% with debt||Median balance|
|HELOC||No data||No data|
|Other installment loans||15.6%||$2,500|
|35-44||% with debt||Median balance|
|Other installment loans||14.8%||$3,700|
|45-54||% with debt||Median balance|
|Other installment loans||11.4%||$4,000|
|55-64||% with debt||Median balance|
|Other installment loans||8.8%||$4,000|
|65-74||% with debt||Median balance|
|Other installment loans||7.3%||$4,700|
|Over 75||% with debt||Median balance|
|Student loans||No data||No data|
|Other installment loans||7.0%||$4,300|
A first step in assessing your debt is separating the good, bad and toxic. A mortgage with an annual percentage rate of 3.5%, for example, can be weighed differently than a credit card with a 20% annual percentage rate.
What’s good debt? When the interest rate is low and fixed, and the loan is used to buy something that grows in value, like a house, business or college education. It’s also good if the interest is tax-deductible, like most mortgage and student loan interest.
Bad debt has crushing interest costs and limits your cash flow, savings and ability to borrow for goals like buying a home.
What’s bad debt? Loans with high or variable interest rates that are used to buy things that lose value or get used up. Examples include high-interest personal loans for discretionary purchases like vacations, auto loans stretching five years or longer, or high-interest credit cards with increasing balances.
What’s toxic debt? Payday or no-credit-check loans with APRs above 36%, loans so long you end up paying more than the item is worth, or loans requiring collateral you can’t afford to lose, like your car.
Bad debt has crushing interest costs and limits your cash flow, savings and ability to borrow for goals like buying a home, says Erika Safran, a certified financial planner with Safran Wealth Advisors in New York City.
On the other hand, a low-interest mortgage that you can comfortably afford shouldn’t keep you up at night.
Figure your debt-to-income ratio
Another question to ask: Is your debt affordable, given your income?
One way financial experts answer this question is by looking at your debt-to-income ratio and teasing out debt that can become problematic.
For this purpose, you can set aside good debts like mortgages and student loans. Rather, add up bad and toxic debts and divide that number by your income. The calculator below does the math for you, diagnoses whether your debt load is manageable or problematic and offers recommendations for what to do next.
The following guidelines aren’t set in stone, but as general rules of thumb, if your debt-to-income ratio for these riskier categories of debt is:
- Less than 15%: Your debt load is within the range considered affordable compared with your earnings
- 15% to 49%: Take action to reduce your debt load; a nonprofit credit counseling agency may be helpful
- 50% or more: Your debt load is high risk; consider consulting a bankruptcy attorney for advice
Are my other types of debt a problem?
The following guidelines give you an idea of how much is too much in these debt categories and what to do if you’re overloaded:
How to handle an overload: Look into refinancing, or consider downsizing or moving to a lower-cost area. If you’re refinancing or changing homes in your 40s or 50s, choose a 15- or 20-year mortgage, so you can be mortgage-free by retirement.
Guideline: Don’t borrow more for a degree than you expect to make in your first year in the workforce. If you expect a starting salary of $40,000, for example, limit your loans to $10,000 per year for a four-year degree. Overborrowing is a common regret among student loan recipients, according to NerdWallet research.
How to handle an overload: Explore your repayment options, including income-driven repayment plans and refinancing.
Guideline: Experts say your total auto costs — including car payment — should stay within 20% of your take-home pay. Car loans should be for four years or fewer and ideally accompanied by a 20% down payment. That way you don’t spend years owing more than the car is worth.
Guideline: Medical debt is a special case since health care expenses are often beyond consumers’ control. This type of debt is generally interest-free, but the amounts involved can make it unmanageable.
How to handle an overload: Try negotiating with the billing office to lower the amount due or set up an affordable payment plan. Take steps to cover the costs on your own if possible, but you may need to look into debt relief.