How much debt is too much debt?
Debt consolidation loans can help you out with any debt issues you may have, but it’s important to recognise that they should only be used when your debts become unmanageable.
Properly managed debt can actually be a good thing – especially if it is moving you toward the goal of increasing your personal wealth. But debt can become crippling if it gets out of hand and can send you into a downward financial spiral in the worst cases.
So how do you work out at what point debt becomes too much to handle?
It’s important to realise that it’s not the overall level of debt that matters as much as your monthly repayments: if these are affordable, then great. If not, then you are going to struggle.
This is why debt consolidation loans can be so helpful; by reducing the overall monthly repayment, they can turn unmanageable debt into manageable debt.
The key metric to consider when looking at whether or not your debt levels are affordable is the ratio between what you spend servicing repayments on personal debt each month and your gross monthly income – your income before the taxman has had his cut. This is known as a debt-to-income ratio.
There is no hard-and-fast rule about debt-to-income ratios, but anything over a third – 33 per cent – of your gross monthly income going on recurring debt could point to problems. This is especially true if you do not have a mortgage, as lenders may be reluctant to offer mortgages to you if your debt-to-income ratio is above the low 40s in percentage terms.
Of course, a mortgage is a debt too, so taking that into account could mean your debt-to-income ratio being pushed further. In these cases, some financial advisers could tell you that almost 50 per cent of your income going to service debt could be okay.
In general, though, a debt-to-income ratio between about 35 per cent and 49 per cent could spell trouble.
That said, this is not a precise rule, and one of the reasons for that is the type of debt you carry has an effect on what is considered manageable. For example, loans secured on an asset like a mortgage are considered a positive, whereas high credit card debt could be much more problematic.