Do You Have Too Much Debt?
We talk about debt a lot on this blog. Good debt, bad debt, how to get out of debt, how to wisely take on more debt, and how to rearrange your debt so that you don’t pay so much on it. But, the one thing people don’t often ask themselves is: Am I in too much debt? Either they think they’re fine because they were just approved for a loan, or they automatically assume that they do have too much debt, even though they may only be carrying a mortgage. So, how much debt is too much? And are you in too deep?
To best figure out if you are carrying too much debt, you need to use the debt:equity ratio that is used by lenders and professionals in the financial industry. In order to figure out what your ratio is, you need to figure out both what your debt is, and what your equity is. To figure out your debt, subtract the amount of your mortgage from your total debt. Then, figure out your equity by determining your total net worth (your total liabilities subtracted from your total assets. Put these two together as a ratio and there you have it, you’ve figured it out. you can then compare it. If your debt:equity ratio is less than 0.5 (or 50%,) you’re fine and you don’t need to worry about being in too much debt. If on the other hand, your ratio is higher than that, you’ll need to take a closer look at your debt situation.
There are some warning signs that you can pay attention to that are good indications that you’re getting into too much debt. First, determine how much of your take-home pay you’re using every month to repay your debts (don’t include your mortgage payment in the list.) But if you’re spending more than 25%, it’s too much debt and you should either find a way to slash it, or start paying it off.
Borrowing more money to repay a loan is also another danger sign that too much debt is creeping up on you. However, there are some exceptions with this one. It’s important to remember that if you’re using home equity to consolidate your debts, such as a home equity loan or a HELOC, these are perfectly acceptable ways to pay off all your debts at once and pay a lower interest rate. However, you should never use a high-interest loan, such as a credit card, to pay for another high-interest loan, such as a car loan.
Lastly, if you’re in so deep that you don’t actually know how much debt you’re currently carrying, the first and most important step is to write it all down and figure it out. You must have an exact number when you’re finished this, because you must know how much debt you’re carrying. This is the only way you can hope to ever pay it off and get back to a secure financial future once again.