Personal finances are complex. There’s no easy answer to the question posed in the title. Two people with different risk tolerances will have different ideas about how much debt is too much. One person might have a higher debt-to-income ratio, but they may also have savings and investments that permit them to take on more debt. There are good debts and bad debts, there are ratios that financial institutions use to determine financial health, and there are a wide variety of financial planning tactics. We’re going to look at all of those.

There’s something we need to address first, though.

Too much debt isn’t totally objective. You can feel it when you’re overburdened by debt. When you’re stressed about bill payments. When you can’t put money away for retirement or emergencies. When you’re getting calls from collection agencies because you can’t pay your bills. In those circumstances, you know you’re in too much debt, no matter what any ratio might tell you, and you’ll need to get your finances under control.

The Good, The Bad, and The Ugly

Debts are often divided into two types: good debts and bad debts. Good debts have a few qualities in common: they tend to be low-interest, they might provide you with tax breaks, and they’re an investment in your future. Student loans, mortgages, and small business loans might all be considered good debts.

You can have an excess of good debts – if you can’t pay your bills, you have too much debt, even if your debts are all solid investments. That’s why there are a number of guidelines for how big a mortgage you should take out. These debts are considered good, however, because they tend to make you more money over time. There’s still an element of luck to good debts – a bad job market can hurt the profitability of a degree, and a downturn of the housing market can devalue your home. Still, these investments are fairly tried and true. Provided you have the finances, taking on these debts can be a very smart move.

Bad debts, then, are the opposite of good debts – they’re high-interest, they don’t pay dividends, and they can quickly leave you trapped in a debt cycle.

Keep in mind that bad debts aren’t inherently negative. A high-interest credit card you pay off every month can be a boon if you get cash back or points. It’s when you’re having a hard time paying debt off that bad debt rear its ugly head, and it’s why reducing and paying off bad debts should often be prioritized.

Ugly debts are the debts you really want to avoid – things like payday loans. You miss a payment on a payday loan, you might have to pay back double – or more. These debts should be avoided altogether – their interest rates are way too high.

When determining if you have too much debt, look at what your debt load is made up of. When you have a lot of good debt, a little bad debt, and no ugly debt, you’re in a pretty good place. Your interest rates should be relatively low, and you may have some wiggle room with home equity.

Read More: 7 Things That Keep People in Debt

The Golden Ratios

The Golden Ratios

There are a lot of different metrics financial institutions use to determine whether or not an individual is financially healthy. Those of you who are looking to buy a home might be particularly interested in the Consumer Financial Protection Bureau’s 43% debt-to-income (DTI) rule.

Debt-to-income is simple to understand: it’s your monthly debt payments divided by your gross monthly income. Someone who makes $4,000 a month gross and has $1,000 of debt payment each month would have a DTI ratio of 25%. 43% DTI is the maximum allowable, in most circumstances, to get a Qualified Mortgage. Qualified Mortgages have certain protections built in – on the good-to-bad debt scale, they tend to lean further toward good than non-qualified mortgages. 

Another important ratio for prospective homebuyers is the 28/36 rule that states that no more than 28% of your gross monthly income should go toward housing, and that no more than 36% should go toward servicing all debt. Conventional lenders love this rule as a metric of financial health, and going over these limits could mean you’re taking on too much debt. Here, it’s important to keep in mind that some debts are better than others – a 38% DTI ratio that is mostly made up of student loan and mortgage payments may be much better than a 34% DTI that’s mostly servicing credit card debt.

Credit utilization is another important ratio. A good credit score is incredibly important for proper financial management because you can negotiate better terms with lenders when they trust you to pay them back. Credit utilization represents how much of your credit you’ve used versus how much you have available. When you’ve put $2,000 on your credit card, and you have a limit of $10,000, your credit utilization is 20%. Keep in mind that credit utilization applies across all available sources of credit. In other words, if you have two cards with $5,000 limits, you have $10,000 in available credit.

You want your credit utilization to be below 30% in order to keep your credit score high. More than that might be considered too much debt. Getting out of credit card debt can be extremely difficult and if it is causing you to stress out, or keeps you up at night, you may want to consider reaching out to a professional.

Financial Tactics

We won’t delve too deeply into tactics because each person’s situation is unique. There are some easy rules, however. When deciding which debts to pay off first it is recommended to pay off the debts with the highest interest rates first. When you’re only making payments on interest, you can end up in a financial crunch really quickly.

Take time to calculate how much debt you have and how much the interest will cost you. A debt of $1,000 at 5% might be prioritized over a debt of $200 at 10%. You might opt to follow the old 50/30/20 rule – 50% of your budget should go to essentials, 30% to discretionary spending, and 20% for savings. When you’re not saving at least 20% of your paycheck, you may have too much debt.

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