Living debt-free is a financial goal we all aspire to achieve. But we live in a world where we rely a lot on borrowing, especially when making significant purchases.
For instance, if you were to buy land or a car, would you use your savings, or would you finance part of the purchase with credit? Some might afford to make such a purchase without borrowing, while others have to rely on debt.
The bottom line is, there are instances in life where one has to borrow for one reason or the other. Unfortunately, these debts can pile up and affect more than just your personal finances. A high debt rate can lead to mental health issues like anxiety and depression.
How Much Debt is Too Much?
The recommended debt-to-income ratio (DTI) is 43%. Anything above this, and you are too deep into debt. The goal is to keep your debt-to-income ratio as low as possible at all times.
To calculate your DTI, get the total amount of your debts and divide it by your income. However, not all expenses are debts. Transactions to classify as debt include:
- Loans, like student loans, personal loans, mobile loans, and auto loans
- Credit card debt
- Child support
Other expenses, like grocery shopping, subscriptions, gas or transport, are not part of expenses. Ensure you do not include these in your calculation.
For instance, if your total gross income is $4,000 per month and your total monthly debt is $1000, your DBT is 1,000/4,000 =0.25%. This is a pretty good DTI ratio and is not a red flag as long as you keep up with your debt payments and don’t accumulate more debt.
Signs You Have Too Much Debt
1. You Have No Idea How Much Debt You Have
No matter how much you ignore your debts, they will not disappear. The more you keep burying your head, the more the credit increases from the accumulated interest and probably more borrowing to stay afloat.
2. Have No Savings
Do you have any savings? Like an emergency fund, savings account for other short-term or long-term goals such as vacations, purchases of electronics, and other assets.
We often get into debt because we lack savings, resulting in using credit to meet unexpected expenses.
3. High Borrowing Rate
If you are always borrowing money for whatever reason, from paying for utilities to emergencies and other expenses, the chances of running deep into debt are pretty high.
4. Making Late Payments
Are you always late on your payments, like rent and loan repayments? This could happen when you spend more on expenses than you make. That means you do not always have money to cover your expenses, leading to borrowing more money to cover your expenses.
5. Living Paycheck to Paycheck
Many people live paycheck to paycheck. Your paycheck will cater to all your expenses, leaving you with nothing to spare. The problem is you will have little to nothing in your savings account if you are living paycheck to paycheck. If there is an emergency or any unexpected expenses, you end up borrowing money.
Good vs Bad Debt
To ensure you manage your finances properly, I recommend weighing where your debt lies when borrowing. Is it a good or bad debt, and where possible, can you avoid borrowing?
Good debt is money you borrow for investments that will ultimately increase your net worth. An excellent example is buying property, land or a house on credit. Properties are appreciating assets, and with time, your property increases in value. You might spend a little more money on interest repayments for the loan, but if you were to sell the property later, there is a high likelihood that you will sell it at a profit. Student loans are also considered a good debt because your certifications enable you to get well-paying jobs that recoup your money with time.
On the other hand, bad debts provide you with no value. Instead, they end up reducing your net worth and affect your finances. A great example is using credit card or mobile loans to pay for your utilities or taking a loan for a vacation.
Read more about 5 Important Things To Consider Before Taking A Loan
What To Do About Your Debt Situation
So, where do you lie? Do you have zero debt, or are you drowning in debt without even knowing? If you have debts, start by listing them down. Then, choose the best repayment strategy, from snowballing to avalanche or the fireball method.
Once you have a repayment strategy in mind, make a budget. It will help you reduce unnecessary spending and put that money into repaying the loans. However, there is only too much you can cut from your expenses.
In that case, find ways to increase your income. You can request a pay raise, monetize your side hustle or get a side job. With this money, you can pay your loans and start building an emergency fund and other savings accounts that help you avoid borrowing money when it is not necessary.