It may seem normal to have debt. After all, total household indebtedness in the U.S. hit a record high of $13.21 trillion as of March 2018.
While it seems like so many Americans carry debt, it may be hard to judge just how much debt is too much debt. There is no “right” amount of debt to have, nor is it easy to figure out how much debt is too much for the average person to handle.
“The appropriate amount of debt is a very personal question,” said Arielle Minicozzi, an executive financial planner at Sphynx Financial Planning. “What feels comfortable for one person may be overwhelming for another.”
There is a point when having too much debt, or too much of the wrong kind of debt can seriously harm your current and future financial situation. When you’re juggling different types of debts, it can be sometimes difficult to realize you have too much owed until it’s too late. We spoke with Minicozzi and other financial experts for their best tips to help tell when you have too much debt on your plate.
Good debt vs. Bad Debt
Debt — in most cases — should be avoided, according to the experts we spoke with. But, some debts make more financial sense to take on than others.
Good debts are debts that help you grow
Debts generally thought of as an investment in your future, like a student loan or a mortgage, are considered good debts. Good debt generally carries a low interest rate and has fixed payment terms, Dan Andrews, a CFP with Well-Rounded Success in Fort Collins, Colo., told MagnifyMoney.
“Our economy allows people to take on debt to pursue opportunities without having to save all the money upfront,” Andrews said. “Lots of people go to school, open businesses and get houses by leveraging debt.”
Andrews adds taking on those kinds of debts — the ones that help you improve your financial life — can be a great way to improve your overall wealth and accumulate assets through your career.
Bad debts slow financial progress
Sometimes we take on what are considered “bad” debts. Bad debts are generally unsecured by an asset and carry high-interest rates on variable terms, like credit cards.
If not managed properly, bad debt can stunt or reverse your financial progress.
“In a perfect world, you’d only use debt strategically because you’d be able to pay cash for everything, however, many of us do not have that luxury,” said Angela Moore, CFP and founder of ModernMoneyAdvisor.
Of course, even good debts can quickly turn into bad debts if you let them spiral out of control, or fall on hard times and struggle to pay them off. For example, you took student loans but did not earn a degree that would have increased your income, or if you took out an auto loan for a car you can’t afford. In these cases, a good debt suddenly becomes a true liability, putting your finances and even assets like your home or your car, at risk.
You can prevent this by being sure you have a healthy emergency fund saved for lean times, and hold yourself back from taking on more debt than you can afford in the first place.
5 warning signs you have too much debt
Beyond just the good and bad, you don’t want to realize you’re in over your head with the debt you’re responsible for paying back. Here are a few warning signs that may indicate you’re getting to that point.
1. You can’t get peace of mind
Minicozzi said the first sign you have too much debt is that you’re feeling overwhelmed and stressed by your bills. If you get anxious at the thought of looking at your balances, and managing your finances is affecting your peace of mind, that’s a red flag you may have bitten off more you can chew.
2. You’re diverting money from your goals
If your other financial goals are suffering, it may be time to make a change. For example, a red flag would be if you are diverting funds away from important goals like retirement savings month after month.
“Once you get to that point, it’s a good sign you need to have an honest conversation with yourself about your repayment strategy,” said Minicozzi.
3. You have no strategy to pay off your debt
If you have a number of debts, you may be making payments each month. But you may not have in place a strategy for finally paying off your debts. If you don’t have a plan that pays off your debts in full, you may have more than what’s manageable for you, according to Moore.
4 You’re not making any progress
Kristi Sullivan, a Denver.-based financial planner at Sullivan Financial Planning, said a main red flag is that you are not making any progress paying down the principal. You are only making the minimum payments, which is just paying off interest each month.
5. The numbers just don’t add up
Looking at a few key numbers may help you point to the conclusion that you have too much debt on your hands for your comfort level. The following are suggested benchmarks and ratios the experts we spoke with suggest you consider when trying to figure out if you have too much debt.
Here are five numbers to check.
Your debt-to-income ratio
“A good rule of thumb is that your total debt payments, including a housing payment, should be no more than 40% of your monthly income,” said Minicozzi.
Your credit score
“Your credit score allows you to put a number on how responsible you are in the bank’s world. The higher the number, the more responsible possible lenders feel you are to repay the loan; so good job to you for being responsible,” said Andrews. Good credit is considered a FICO score of 670 or higher.
Your credit utilization
A high credit utilization ratio — which measures the overall credit limit you are using up — can indicate you’re leaning on your credit cards too much to make ends meet. The utilization ratio is the second most important factor in determining your credit score so reducing your utilization could improve your score, too.
“As far as maximizing your credit score, keeping balances on your cards below 20%-30% of their limits is ideal,” said Minicozzi.
For example, if your overall credit limit on all of your accounts is $10,000, your goal would be to use less than $3,000 of your balances on those cards.
Your net worth
Your net worth is just a step further than your debt-to-income ratio. If your net worth is negative and you own valuable assets, it may be an indication you should focus on paying down your debt to bring that number into the positive.
Your housing expense
Housing is the largest expense for most households, and a necessary one. A mortgage is considered good debt, or even an asset by some. On the other hand, a mortgage you can’t afford could leave you with too little left over to cover other bills and savings. Moore advised you pay no more than 28% of your gross income on housing.
Action steps to take if you have too much debt
After you’ve found you have too much debt, you can start planning to pay it off.
Create a budget
“While some people are in debt due to factors outside of their control such as medical expenses, mostly it is because of choices that now require sacrifices to reverse. Get ready for life to change, at least while you are digging out of debt,” said Sullivan.
Find expenses to trim
“You may be living in too nice of a house or apartment and need to adjust your living situation. Roommates or a less desirable area of town to cut down on housing costs can free up big chunks of cash to pay down debt,” said Sullivan. She added downgrading your car choice (changing to a car that costs you less to own and/or maintain) will lead to lower taxes and insurance costs on transportation.
Make a debt payoff plan
With your unsecured debts, you can employ one of two debt paydown methods: the debt snowball and the debt avalanche.
When you snowball debt, you order all of your debts by balance and prioritize paying off the account with the lowest amount first. If this method suits your personality, paying off lower balance loans may motivate you to pay off the remainder of the debt.
The avalanche approach has you order your debts by order of interest rate. Prioritize paying off the account balance with the highest interest rate while still making minimum payments on the other debts. The avalanche method saves you money in the long run since you can avoid paying the most interest and address the principal of your debt faster.
Whatever you do, don’t “wing it” with debt repayment, Andrews said, “A ‘winging it’ mentality can snowball out of control, especially if there is credit card debt.”
Try consolidating your debts
If you find it’s difficult to manage several debt payments each month, debt consolidation can help to simplify your debt payoff process. Debt consolidation can combine multiple debts — like credit card debt, auto loans, medical debt and student loan debt — into a single debt with one monthly payment. In some cases, consolidating your debts could even save you money on future interest payments as you pay down the balance.
If you use a personal loan for debt consolidation, you’d pay off other debts using the cash you’d receive from the personal loan, then pay down the personal loan in monthly installments.
When you use a balance transfer credit card, you can transfer the balances on your credit cards to another credit card with a 0% intro APR. Intro offers typically last from six to 18 months.
Ask for help
If you’re struggling to repay the debts and stay consistent, you may want to reach out to a credit counseling service or a financial planner to help you create a budget and debt repayment plan that works best for your financial needs.
“As long as you can pay your bills without sacrificing your long-term goals and as long as you aren’t stressed out over the level of debt you have, you’re in a good spot,” said Minicozzi.