Debt. It’s a word consumers are very familiar with, as the average American household carries $5,700 of credit card debt, and the average member of the college class of 2016 carries $37,272 in student loan debt.
We can always strive to live debt-free lives, but most of us do have to go into debt for certain things, like buying a house, or replacing a car, or going to college. And despite what some people would tell you, debt isn’t, by itself, a bad thing. But too much debt is like playing with fire. In order to really answer questions about debt, we need to explain the different types of debt, and show where the tipping point might lie for you in determining how much is too much.
There are two types of debt: Secured and Unsecured
Secured debt is things like mortgages and auto loans. These are backed by security (otherwise known as collateral), which means your house or car can be repossessed if you don’t pay back the debt.
Unsecured debt, meanwhile, is things like credit card debt, medical bills, and student loans. These are only backed by your promise to pay. There are options for lenders in these cases if you don’t pay (like legal action), but they’re much less concrete than with secured debt.
Is your debt causing you concern?
Your debt-to-income ratio is an important metric of your overall financial wellbeing. Your debt-to-income ratio looks at your gross monthly income (what you earn) and how much of that income goes toward paying rent or mortgage, auto loans, student loans, credit cards and other debts. To calculate debt-to-income, take your monthly debts and divide that by your gross income (income before taxes are taken out).
How much debt is too much?
At Arbor Financial, we have some general debt-to-income guidelines to consider when reviewing your finances.
You are in a healthy position and should be accumulating savings. Unforeseen expenses should not throw you into a financial crisis.
36% - 49% - Fair, look to improve
Your debt may not be out of control but there is room for improvement and you should consider lowering your debt payments. If an unforeseen expense happens to come your way it could potentially put you deeper into debt and even push you into unfavorable position.
50% or higher – Bad, time to take action
More than half of your income is going toward debt leaving you with little room for every day expenses, like gas, groceries, leisure, TV, cell phone bills and the alike. You may likely have little to no money left over for savings and one small unforeseen financial expense will require you to borrow money.
If your debt-to-income is 50% or higher, it’s time to talk to a financial counselor who can help guide you.
Additional signs that it's time to seek assistance
Just as important as the debt-to-income ratio, however, is taking a look at what you’re doing to create debt. Here are some signs that could indicate it’s time to seek assistance:
Your credit card balances are rising but your income is not
You are only paying the minimum amounts required on your accounts
You consistently charge more each month than you make in payments
You are using new credit or cash advances to pay bills
You are over the limit on any of your credit cards
You are hiding the true cost of your purchases from your spouse
For many people, a financial counselor can help them get organized and lend support. A good first step for Arbor Financial members could be to participate in our complimentary credit checkup. The experts can review the member’s credit report, offer ways to consolidate debt and improve their credit score.
Members of Arbor Financial Credit Union, can also take advantage of the GreenPath program, a free financial education and counseling program. Find out more about GreenPath by clicking here.
A critical part of achieving your financial goals is managing your money appropriately. Arbor Financial has the experts with the experience to help you take charge of your money at any age, and to help you and your finances get where you want to be.