DEBT.

Nearly half the US population has it. And if you’ve ever listened to Dave Ramsey or Suze Orman then you know that technically you shouldn’t have debt either.

But this is real life.

And most of us have needed it at some point or the other to attend college, buy a house, a car or just get through a rough patch. But if we aren’t careful it’s very easy to cross over the line of having an acceptable amount of dent, and being in over your head.

So in this article, I want to give some guidelines that I use to help folks assess how much debt is too much debt. I’ll make the disclaimer that these are my preferences and comfort level for debt (especially in terms of interest rates, and loan lengths).

Because personal finance is well ya know … personal

None of the details below are meant to shame or alarm you. It’s meant to alert you to take a closer look at your debt and take some action as needed. so here goes:

1. You Have High Credit Card Debt

You know as well as I do that some debts are worse than others. For example, mortgages and student loans are considered relatively okay/acceptable as long as the terms are reasonable (we’ll discuss that later).

But some debts are deadly and if you have them then your infected.

High-interest revolving debt like credit cards and payday loans are bad news. And I hate to generalize, but in my experience, if you have high credit card debt, then you’re in trouble.

If you are using payday loans or credit cards and are carrying a balance each month, then it’s likely you can’t cover your expenses with your income and you’re in over your head.

I know that sounds harsh, but let’s look at it.

Credit card debt can carry high-interest rates well into the double-digit territory – as high as 36%.

The average amount owed on credit cards for 2018 is $5700. On a $5700 revolving balance with an average of 15.32%, you’d pay nearly $1500 in interest every year.

And that’s assuming you stopped charging the card.

Furthermore, because they are unsecured, there’s nothing tangible that you can return to the lender to cover some of the debt if you hit on hard times.

So card companies can ruin your financial life by garnish your wages, demolishing your credit and even suing you to get their money.

The one exception I would say is if the terms were excellent – basically near ‘same as cash’ and you were working to pay it down without incurring any interest.

Rule of Thumb on Types of Debts:

GoodNeutral/
Acceptable
Trouble/
In Over Your Head
Debt TypeIncome-
Producing
(eg. rental mortgage)
Mortgage
Student Loans
Auto Loan
Credit Card
Personal Loan
Payday Loans

2. You Have Excessively High-Interest Rates or Bad Terms

Terms can make a ‘good’ loan bad, and a bad loan downright awful.

Loan terms refer to can the type of loan, length of time, amount of interest, type of interest (fixed or variable) and other specifics of the loan.

Loans or debts with high interest rates, excessively long payment schedules or with dangerous (uncapped) adjustable rates can cause you to get way over your head.

The general rule of thumb for debt terms are:
* Regarding interest rates – the lower the better.
* On the length of term – the shorter the term the better.
* And when choosing interest rates, fixed is always best.

To give you more guidelines on what gets classified and how, check out the following tables around my good, okay and ugly of loan terms. The general idea if once you are below the average rate you are pretty good. If your rate in the average range, then you are ‘okay’, but if it’s worse than the average then you’re in bad terms and might want to get out.

Interest Rates*

Debt TypeGoodNeutralOver Your Head
Mortgage<3%
3 – 5%>5%
Auto Loan<5%6-10%>10%
Credit Cards<10%10 – 18%>18%
Student Loans <5%6 – 8%>8%
Personal Loans<8%9 – 14%>15%
Payday LoansJustDon’tDo It …. Ever

Another quick and dirty guideline on debt interest is that the interest rate should never exceed the average rate of return if it were invested i.e. 7% or 8%

Type of Interest Rate

TermsGoodNeutralOver Your Head
Interest TypeFixedAdjustable Rates
Balloon Payments

Fixed interest rates are more favorable because your monthly payments will not change and you don’t have to worry about rising interest rates. Having predictable payments helps folks budget better.

Balloon loans allow for interest only to be paid for the first few years of the loan, and then the outstanding balance is due at the end of the period. It’s seriously bad news.

Most people aren’t going to pay extra to make a dent in the principal so when the end of the period comes, they likely owe the whole loan.

Length of Term(in years)

Debt TypeGoodNeutralOver Your Head
Mortgage<10 – 1520 – 30>30
Auto Loan<44 – 5>6
Student Loan<7 – 1010 – 15>15

Why are bad terms so bad?

Because they can make you pay more.

The higher your interest rate, the more you pay in interest. And the longer you carry the loan is the longer time you continue to make payments, resulting in paying more. Let’s compare a fairly good term loan to an average term loan.

Imagine buying a house for $200,000. You make a 20% downpayment and sign up for a 30-year mortgage with a fixed 4% interest rate. By the last payment, you would have paid $200,000 for the house, plus an additional $114,990 in interest for a total of $314,990.

That’s over 50% more than what you paid for the house!

Meanwhile, if you had taken a 15-year mortgage you would have paid $53,030 in interest for a total of $253,030. And that’s comparing a good loan to an okay loan.

Imagine suffering under a 27.99% credit card interest rate on a $10,000 credit card balance. For each $300 minimum payment you make per month more than half ($233 actually) will go towards your debt principal. It’ll take you over 30 years to pay off the loan and pay $31,850.54 in interest – over 3 times how much you borrowed.

3. You’re paying more than 25% of your salary servicing debt

Yes, it’s just as awful as it sounds. If you are paying more than 25% of your take home income just to cover the minimum balance on your debts then you are in trouble.

The table below shows the consumer debt percentage (excluding your home loan and education loan), the represented dollar value based on a $60,000 household income, and where it ranks on the scale of good to over your head.

Consume Debt as
% of net monthly
income
Min Payment
Dollar Amount
based on 5k
Monthly Income
Rank
No consumer debt$0Doing Great! Fantastic
Up to 10%< $500Acceptable
10% – 25%$500 – $1000 Take Action
25% – 45%$1000 – $2250Problem/
Over Your Head
Over 45%>$2250Drastic measures

I’m sure I don’t have to tell you why spending more than 25% of your salary is bad, but I like to make sure folks understand why somthing is a problem so here you go.

The generally accepted breakdown of how to spend your salary is the 50-30-20 rule. The idea is that you should spend no more than 50% of your salary on your living expenses (bills, housing etc.), no more than 30% on things you enjoy, and the remaining 20% for future goals – paying off debt, saving for retirement etc.

Of course, no one perfectly fits into this category.

In fact, most of us are a little lopsided with higher living costs on the west and east coast. But if you’re spending over 20% on servicing your debt, then you aren’t saving for retirement, an emergency fund or any other goals for that matter.

But that’s okay, we can take the rent money from the fun pile right? Well if you need to use your fun money to fund your future goals, then you are simply working to pay bills and can’t even enjoy the fruits of your labor.

You my friend, have too much debt and are in over your head. You need to make some changes.

4. You Have Waaaaaay More Debt Compared To Your Peers

My parents always taught me that you shouldn’t have any debt. But there comes a certain point in a person’s life when they are usually at the height of how much debt they possess. For example:

Those childbearing years, when you are just out of college with high student loans. Your salary is low because you are fresh in your career. You have daycare or college bills for your kids, and you likely just bought your home a few years earlier so you are on the front end of your mortgage.

Most people in similar situations – kids, salary range, city of housing, lifestyle choices etc. – are in similar debt ranges.

But if you are an engineer and you have $200,000 in student loan debt for your degree, while other engineers graduate with $40,000 in student loan debt, then it’s a good indication you might have more debt that you should (at least in that arena).

It’s not to say that just because other people are in debt then it means it’s okay for you to be in debt. I’m just saying that some times in our life our debt load is higher and if you are on par with others in the same situation it can be a good indicator that you haven’t gone off the deep end.

5. You’re borrowing more to upgrade your lifestyle

You know you’re in way over your head on debt if you are borrowing to upgrade your lifestyle.

Sure medical emergencies happen, you get in an accident and have to quickly replace your car, or you need a student loan to cover the last semester of college.

But buying a new car because you got a raise at work or buying a house because you feel its the ‘adult thing’ to do is a recipe for disaster.

You have to be honest with yourself . Brutally honest …. about your motivations. And have enough hutzpah to stand your ground if getting a laon will dig you further into a hole you can’t escape.

6. You feel overwhelmed by your debt

Probably the largest indicator of if your debt is too much is how you feel about your debt.

If thinking about your debt keeps you up at night. If it causes you anxiety and fear about the present and/or the future. Or if it leaves you overwhelmed, exhausted and frustrated with yourself or your spouse, then you have too much debt.

It doesn’t matter what anyone tells you. You will not take action with your debt until you feel that it’s time to make a change.

Take Action

Having too much debt doesn’t mean that you HAVE to file bankruptcy. It means that you need to stop managing your debt and do something about it.

Here comes the good news.

There are lots of options available for getting your debt under control. You can make a plan to get out of debt and start putting every free dollar on the lowest balance card until it’s paid off. Then move to the next card. See the debt snowball payoff method.

You can also consider doing a loan consolidation with companies like Sofi, Lending Tree and many others. This can help lower your interest rate and your minimum payment so you can pay down your loan faster.

If you’re in crushing debt, then you may want to consider talking to an attorney about any bankruptcy options available to you.

It can’t be any worse than it is right now.