How do I know if I have too much debt?
How much debt is too much debt?
Some describe the four walls of household finances as food, shelter, clothing and transportation. Food prices continue to rise and according to the USDA there are above average increases in retail beef and veal, pork, eggs, fish and seafood, dairy, and fresh fruit. Housing prices increased in the first quarter of 2015, and there continues to be an increase in sales for both the clothing and auto industries. As we look at the four walls and beyond, an important question to ask is how are we able to pay for the mortgage, a car payment, credit cards, and don’t forget the student loans that paid for your education? As consumers gain more confidence, another important question to ask is how much debt is too much debt?
You may be able to afford your monthly payments now, but what if you lose income? What if you experience an emergency? One way to measure your debt is by calculating your debt ratio. A debt ratio is calculated by dividing the total amount of your monthly debt payments by your monthly take-home pay. Based on your answer, you may learn that you are carrying a safe amount of debt, or you may learn that you are a disaster waiting to happen.
For example, if you are paid $14 per hour and work 40 hours a week your gross earnings (before taxes) are $29,120 per year or just over $2,426 per month. After taxes you may only take home around $2,200 per month depending on your tax withholdings. What if you have two credit cards, an auto loan and a student loan? If we assume fairly modest monthly payments, let’s look at the following:
Monthly Debt Payment / Take-home (Net) Pay = Debt Ratio
45 (Credit Card payments)
238 (Auto loan payment)
+ 267 (Student loan payment)
$550 / 2200 = .25 or 25 percent
In this example, your debt ratio would be 25 percent. According to the work sheet found on the MI money health webpage, a 25 percent debt ratio would mean “Red Alert!” You are overextended and in need of dramatic changes. According to the formula, a ratio of 10 percent or less equals a safe limit, but a ratio of 26 percent or higher equals disaster.
Find out your debt ratio by visiting the MI Money Health and using the debt ratio worksheet to plug in your numbers. If you have too much debt and want to find out how you can make a plan to manage your money, Michigan State University Extension offers a variety of money management programs throughout the state of Michigan.