Are you out of your debt comfort zone? Does it seem as though you're paying too much to bill collectors and not enough for savings and the things you enjoy in life? If so, it's a good idea to figure out just how much debt you have and compare that to how much you earn. This will give you clear understanding of your financial health.
Debt LoadThe first step is to calculate your debt load. This is the total of all the money you owe:
- Student Loans
- Credit Cards
- Even loans from friends and family
Once you have your debt load figured out, you'll want to know how big of a burden it is. You can do this the way banks and creditors do, by calculating your debt/income ratio – the amount you owe compared to the amount you earn. It's easy:
- Calculate all your monthly debt payments – including credit cards, mortgage and child support. (If you don't have fixed monthly payments, you can estimate your monthly payments at four per cent of the total amount you owe.)
- Take your gross annual wages and divide them by 12. That's your monthly income.
- Take your total monthly payments and divide them by your monthly income.
- Move the decimal point two digits to the right to make it a percentage. That's your debt/income ratio.
Here's an example. Let's say your monthly income is $2,000 and your monthly payments on your debt load totals $500. If you divide 500 by 2,000 you get .25. Move the decimal point two places to the right and you get 25% as your debt/income ratio.
How much is too much?
Only you can know for sure how much debt is too much. If you're feeling squeezed every month because of credit card bills, you don't need anyone to tell you you're out of your debt comfort zone – you already know.
But as a general rule of thumb, a debt/income ratio of 10% or less is outstanding. If it's between 10 to 20%, your credit is good, and you can probably borrow more.
But once you hit 20% or above it's time to take a serious look at your debt load. Creditors will be less likely to give a loan to someone with such a high debt/income ratio, and those that do will probably charge higher interest.
Worse, if you have a debt/income ratio above 20%, chances are you'll feel a strain on your budget.