Recent statistics show most of the Americans live on debts. In fact, one study shows that 65% of US citizens are on interest payment. This shows the extent to which people rely on debts. Personal loans are so beneficial but can be so hard to handle some times. Indisputably, there are circumstances in life that necessitate borrowing.
For instance, what can you do if an emergency strikes and you do not have savings to cover the unexpected costs? Isn’t borrowing sensibly in such a situation? Think of a medical condition that requires urgent attention. Are reasons for borrowing not justifiable? Sometimes it may not even be an emergency, but rather a situation that just demands the funds you do not have.
Borrowing is not bad. It only becomes a problem when you cannot make the best out of the borrowed money. This often involve comparing loans before applying to make it worthwhile check out A1 Credit for better options. Even though the conditions may push you into borrowing, debts can detriment your financial status. This is especial the case when you are used to payday loans. Generally, it takes a very short time to be approved for these loans. Even the requirements for approval are not too much demanding. Nevertheless, the interest rates are often very high it has become extremely difficult for individuals to find their way out of these loans.
Do not allow yourself to live on debts. Remember that money lending institutions are in business and will want to profit from you. The fact that you qualify for a loan does not mean that you need it, or rather you should have it. It is so unfortunate that many people have taken too many debts than what they can actually handle.
But then, how much debt is far too much? Well, there is no set amount beyond which someone should not borrow. This is because individuals have different conditions and different levels of income. But still, it is possible to tell if you are carrying too many debts. This blog will help you determine the level of debts you can afford and signs showing you just have too many debts.
The Amount You Can Afford
Knowing how much of a debt you can afford is very important. Irrespective of what you earn, there is one standard model used to calculate the level of debts that can become detrimental. This what we call debt-to-income ratio, initialized as DTI. It does not involve too much. The math here is quite simple. Take your monthly frequent debt and divide by your gross income. Let us show it this way:
Frequent debt ÷ Gross income = DTI
So what are these recurring or frequent debts? Well, these are the payments you must make on a monthly basis and may include the following:
- Mortgage payment or rent expense
- Student loan payments
- Car loans
- All the monthly bills
On the other hand, your monthly gross earnings include the total income you receive before taxation, insurance premiums, and social security among other deductions made from your paycheck. It will be easier to contextualize if we take a practical example here.
Assuming that you earn a gross income of $5500. Suppose you pay a mortgage of $650, a car loan $550, credit card $950, and student loan $450. Your total recurrent debt will be $2600. Your debt to income ratio will be calculated as follows:
Frequent debt ($2,600) ÷ Gross income ($5500) = DTI 0.4727, or 47.23%. This just too bad.
Basically, a DTI greater than 43% is considered unhealthy and you may not be approved for a mortgage loan. Most of the lenders prefer 36%. But that is not our interest for now. The implication of this ratio to someone living in debts is important.
Essentially, financial experts are of the opinion that a Debt-to-income ratio that is greater than 28% implies you have a lot of debts. Others have set a DTI limit of 20%. In reality, it is so easy to accumulate debts but just so hard to acknowledge that you have gone too far. Apart from the debt-to-income ratio, how else can you tell you have just taken too much and perhaps headed to a financial crisis? This question leads us to the last aspect we wanted to address…
Indicators of Too Much Debt
To effectively manage your debts, you must know the problems you already have. For instance, ask yourself some instrumental questions such as: is debt your lifestyle? Do you often borrow to finance huge purchases? If your answer is yes, then this is a clear indication of having too much debt than what you can practically afford. But if you acknowledge the indicators earlier, it will be easier to take measures to readjust your spending and salvage your condition. The following signs will tell whether you have a lot of debt than you should:
- Debt payment consumes all your earnings. Take time to determine how much you spend on repaying debts every week. Begin by assessing credit cards as well as other key financial reports. Find the sum of your minimum payments and weigh the total against your monthly income. Your payments should not be greater than 36% of your total earnings per month. If you incur at least 50% of your income, then you need serious adjustments.
- You cannot be approved for a loan. Your credit score is always used to determine whether you qualify for a loan. If you have too much debt, you can hardly be approved for new credits.
- Late payments. Failure to keep up with payments is a clear indication of having too much debt already. You end up forgetting the due dates and lenders. Having too much debt detriment your credit score. But failure to submit payments in time worsens it.
- You take a loan to settle bills. Borrowing either from friends, banks or even family members in order to settle your bills show you owe too much. You, ultimately, go short of places to borrow from and now you have to finance your bills with the help from those close to you.
- Drained saving accounts. Not having a saving account is normal. But if you had one but now it has zero balance because of settling debts or to keep moving, then it is an indication of problems.
- Lack of sleep due to finance issues. If you lack sleep due to the distressing financial condition, know that your debt is beyond control.
There are so many other indicators that can tell your financial condition as far as debts are concerned. You only need to be careful to acknowledge them.
How much debt is too much? While there is no set amount, you can use a debt-to-income ratio to tell whether you owe too much than what you should. You can also use other indicators to know the level of your debts. Once you have acknowledged there is a problem, start looking for ways of fixing it.