Debt can be a useful means of paying for a variety of outlays, such as a house, car and other items which are necessities for some people. In many cases, debts are kept to manageable levels and are paid back on time and in full.
In other cases, though, debt can become a major challenge for consumers. People may find it difficult to repay the full amount or even to service the interest costs associated with it. And while there may not be a universal level of debt that is ‘too much’, it is possible to give a guide as to whether an individual’s debt is becoming unaffordable given their personal circumstances.
Debt-to-income ratio
One means of determining whether an individual has too much debt is to calculate their debt-to-income ratio. This is a simple calculation that provides a guide as to whether a specific amount of borrowing and expenditure is affordable given an individual’s income. Debt-to-income ratio may prove useful in providing a rough estimate of whether indebtedness could become a problem in the future.
The debt-to-income ratio is calculated by adding up all debt repayments and interest payments per month, such as mortgage costs, credit card payments and car payments. The total figure is then dividend by an individual’s monthly gross income (i.e. before tax deductions) to arrive at a decimal figure. This is then multiplied by 100 to give a percentage, which equates to an individual’s debt-to-income ratio.
For example, if an individual has total debt payments of £1,000 per month and earns a salary of £2,000 per month, their debt-to-income ratio would be 50%.
Although the figure that suggests that an individual’s debts are too high relative to their income is subjective, generally a ratio of more than 40-45% is considered relatively high.
Seeking out help
Of course, it may be more relevant for some individuals to consider how they manage their finances rather than focusing on a statistical measure. For example, someone whose debt levels are constantly rising or who is struggling to make the minimum credit card repayments each month may have too much debt for their personal circumstances. Likewise, such a person may be borrowing to fund everyday expenses, and the cost of servicing the debt may be taking up a large chunk of their monthly after-tax income.
Individuals finding themselves in such a situation may want to seek expert advice on how to manage their debt. Products such as a balance transfer card may provide breathing space that enables an individual to put their finances in order, for example. Similarly, putting in place a realistic budget each month may help to reduce debt and rebuild an individual’s credit score in the long run.
Takeaway
Ultimately, there is no specific figure that provides a clear line as to when debt levels have become excessive. The amount of debt that is too much depends on an individual’s personal circumstances, although the debt-to-income ratio can provide guidance. So too can factors such as whether debt levels are constantly rising, and how easy it is to make repayments each month.
As ever, debt can be helpful when used appropriately in order to fund the purchase of large items such as a house or car. But it is all too easy for debt to rise to unmanageable levels. Taking action now to ensure debt levels are not too high could, therefore, be a shrewd move.
