Most of us will take on debt at some point in our lives. Whether it is a mortgage, student loan, credit card or personal loan, borrowing money can cause stress. Less debt always sounds like a good idea, but this can be a bigger challenge than we realize. And avoiding debt completely may not even be as important as we think. You can find some details about debt below to help you better assess when it may be OK to take on some of it.
The General Rule
You may think having no debt is the goal – and for some people that might be true. If owing even a small amount of money makes you so anxious you can’t sleep or your health is otherwise suffering, you might be better off avoiding all debt. But for most people, it’s important to find a manageable amount of debt. Borrowing some money is generally needed for some of life’s biggest purchases like buying a home.
Before taking out a mortgage or a loan, it’s important to do some research and have a plan. It’s good to know how much you need to borrow, how much money you will pay for borrowing that money (in fees and interest) and how long it will take you to pay it back. Having a budget that shows you how much money you have coming in and how much you owe can help. It’s always good to be aware of how the size of your debt compares to the money you make. Your debt-to-income ratio (DTI) is how much you owe in monthly payments over your gross monthly income.
Debt By the Numbers
Your debt-to-income ratio tells you a lot about your financial health. Of course, the actual number of dollars one can safely be indebted is different for everyone. The general rule of thumb for mortgage underwriting, for example, is that a debt-to-income ratio at or below 36% is preferable. The lower the number is, the better your balance between debts and income. The number will almost always come up in the lending process.
How much debt you are carrying will also affect your credit utilization rate, a major component of credit scores. It’s generally recommended that you keep your credit utilization rate — how much debt you are carrying versus how much credit has been extended to you on revolving accounts like credit cards — below 10%, though, again, the lower the better. You can keep an eye on your credit utilization rate by monitoring your credit. (You can get your free annual credit reports at AnnualCreditReport.com or see your credit scores for free each month on Credit.com.)
Understanding Your Debt Status
Though managing your debt is related to your income and personal financial situation, it is always good to look at your debt more closely. You may want to divide debt into good debt and bad debt – by lender, reason you borrowed, amount or even interest rate. Going beyond the ratio to assess how you take on debt and how much of each type you have can give you a more complete picture of where you stand financially.
Now that you know more about gauging how much debt is manageable, you can evaluate what you currently owe. If you have too much debt, it can be a good idea to go through your budget to cut down spending and focus on repayments until you’ve gotten a better handle on it. Your debt has a big impact on your credit score, spending power and overall financial health. You cannot afford to ignore it — but it’s OK if it exists.
More on Managing Debt:
- The Credit.com Debt Management Learning Center
- How to Pay Off Credit Card Debt
- Understanding Your Debt Collection Rights