Too Much Debt? Identify and Learn the Signs of Too Much Debt

Almost everyone has some type of debt, and not all debt is bad debt. Your debt may be completely manageable, or it could be a time bomb waiting to go off. Here’s how to know if you’re in a situation where it might be smart to start investigating debt consolidation loans, debt settlement, debt reduction programs, and other types of debt relief.

How to Identify Whether You Have Too Much Debt

As a general rule of thumb, keeping total monthly debt payments below about 36% of gross income is considered an ideal target. A DTI of 43% to 50% can still be considered healthy.Once debt payments exceed 50% of gross income, borrowers may become financially stretched, especially if they have limited savings or irregular income.

Calculating DTI isn't hard. First, add up all of your income. Consider all sources, including:

• Your salary from full-time or part-time work (use the before-tax number)

• Money you earn freelancing 

• Pensions

• Bonuses or commissions

• Tips

• Child support or spousal support you receive

• Social Security or disability income

• Rental income

• Retirement account distributions

• Investment income

Then add up all of your minimum debt payments. Do not include utilities, groceries, or other expenses that aren’t debts. Here’s what you should include in the total:

• Credit card minimum payments

• Personal loan payment

• Car or motorcycle loan payment

• Student loan payment

• Home equity loan or HELOC payment

• Minimum payments for any loans you co-signed

• Rent or mortgage payment. The mortgage payment total should include the principal and interest loan payment, plus homeowners insurance, property taxes, and monthly HOA dues.

• Time share payment

• Child support payment

• Spousal support payment

• Court-ordered payments for a debt not listed here

Total up your debts and divide that number by your total income. Then multiply the result by 100 and that’s your DTI. Here’s an example.

Generally speaking, lenders won’t bat an eye when your DTI is under 36%. What if it’s higher? Many mortgage lenders can approve applications for borrowers with a DTI of up to 50%. But with a DTI that high you might be turned down for other kinds of loans. A lower DTI could help you qualify for a loan when you need it. 

Why do they have these cutoffs? Because it shows how strained your budget is. Having less money leftover after you pay your required bills means it’s harder to save and harder to bounce back from unexpected financial emergencies. The less wiggle room you have in your budget, the more it looks like you might not be able to afford your debt.

6 Signs of Too Much Debt

Watch out for these warning signs that your debt is spiraling out of control.

1. All your money goes toward your debt

If you don’t have any disposable income left at the end of the month after paying your debts, you’re in a vulnerable financial position. One unexpected event, like a medical expense, car trouble, or job loss, could force you to rely even more on your credit cards and increase debt beyond what you may be able to manage on your own.

2. You are struggling to make minimum payments

If you only make your minimum payments each month, your credit score reflects that you’re keeping up with payments, but you’re not making headway in debt reduction. The longer you’re in debt, the harder it could be to change your situation.

3. You can’t get new credit

To decide if they’ll extend credit, a company will usually review the income listed on your application as well as the debt that appears on your credit report to calculate your debt-to-income ratio. If they think you have too much debt for your income, they may assume you’re at high risk of default and won’t approve you. To improve your situation, try to reduce your DTI by paying off debt or increasing your income.

4. Your savings account is empty (or nearly empty)

To have healthy finances, it’s recommended that you have enough to pay three to six months’ worth of expenses in a savings account that’s easily accessible should you need it for an unexpected expense. If you don’t have this much, make an effort to save more. If you aren't able to save more or are pulling from your savings to pay off debt, consider it a sign that you are not on solid financial footing. When an emergency happens, you don’t want to be forced to use high-interest credit cards.

5. You’re shuffling your credit cards

It could be smart to take advantage of balance transfer offers to move your high-interest credit card debt to a lower-interest credit card. Some balance transfer cards even offer a temporary 0% APR. A balance transfer could reduce the interest you pay in the short term. Your debt still exists after the transfer.

A low promotional rate doesn’t last forever. It goes up after a certain amount of time and could go as high or higher than the interest rate you had before the balance transfer. Then you’re right back where you started. If this is your method of staying one step ahead of your debts, it is not a long-term solution.

6. You’re stressing over your debt

Debt that’s on your mind often during the day could distract you from focusing on work or family, and that’s no way to live. Debt that disrupts your life daily is a sign you should explore finding debt help.

Good Debt vs. Bad Debt

Not all debt affects your finances the same way. Debt used to build an asset or increase your income, like a mortgage or a student loan, is often called “good” debt. Debt used for purchases that lose value over time, like credit card debt for everyday expenses, is often called “bad” debt.

The type of debt matters less than whether you’re able to afford it. A large mortgage payment on a stable income could be manageable. A small credit card balance could be a problem if it comes with a high interest rate and you’re only able to pay the minimum.

A guideline for non-mortgage debt

DTI isn’t the only benchmark to consider. Non-mortgage debt, like credit cards, car loans, and personal loans, is generally best kept under 20% of your income, if possible. However, this isn't an absolute guideline, and it's not realistic for everyone. If you're earning $50,000 a year, for example, your debt payments may take up more than 20% of your income.

Another Financial Ratio to Measure Debt

DTI isn’t the only way to measure how you’re doing. You could give yourself a financial check-up using credit utilization. This is how much you owe on your credit cards compared to your credit limits on all of your cards. The lower the better. 

You still don’t want any one card to have a high utilization. High utilization on a single card could lower your credit score and make it harder for you to apply for new credit when you need it.

Using ratios could help you understand your finances and give you a heads up if your debt is becoming outsized, compared to your income.

Also, debt is expensive. The more you have, the harder it could be to knock it down. Understand these numbers so that you feel comfortable and confident about your debt as you work toward a better financial future.

Dealing With Too Much Debt: Your Next Step

Several types of debt help are available. Debt consolidation loans and debt settlement programs, like the one Freedom Debt Relief offers, are just a couple of examples. The key is to explore your options as soon as you know your debt is a problem.

Debt settlement may negatively impact your credit.

A good place to start is this debt solutions overview. It offers pros and cons for the most common debt solutions and lets you learn more about each one.