How Much Debt Are You In?

Managing Your Debt

How Much Debt Are You In?

10th June 2007

I have received in total 71 emails from readers (you guys) all asking me when it is that they should consider themselves as being in bad debt. First of all I think you should ask yourself the question 'how bad is it?' Bad debt does not start when creditors start making harassing phone calls to your home or workplace or mobile. Bad debt also does not start when you begin to receive warning letters through the post to pay your bills or face legal action. If I compare the experiences I went through both times I nearly went bankrupt, I can say for sure that bad debt is not something that happens overnight. I think bad debt is the end result of a snowballing process that could take as long as two years to finally escalate into what we know as bad debt.

Managing Your Debt So how do you end up in bad debt? It all starts with making bad and uniformed financial decisions. The second time I went nearly bankrupt, I had bought myself a luxury car, I had a good cashflow. I had money in CDs (Certified Deposits), and I had an overdraft facility of $8,700 which was revolving credit. Important to note here is that having an overdraft facility when you are as financially indisciplined like I was at the time is that the $8,700 appears as a credit to your account except, spend a cent of it and you've got to start repaying the bank for it. This facility cost me $217 monthly. I did not look at the long term implications of what my purchases would cause.

I purchased a beautiful 3 bedroom home and then took a second mortgage to make some renovations. Then I went out and got myself a brand new Mercedes Benz. The car cost $40,000 and the initial repayment was $746. I had two credit cards with a combined total debt of $11,000. You can already see trouble brewing because the minimum balances on all my debts left me with only $500 from which I had to pay for gas, food, water, electricity and taxes. As interest rates went upwards you can guess that I fell into bad debt.

You don't need to wait until the situation is as bad as how mine ended up being in order to take remedial action. By the time I decided to rectify my finances I owed $12, 345 in consumer debt excluding my mortgage per month! Start a monthly debt update. You can do this by working out your debt-to-income ratio. The debt-to-income ratio is calculated by dividing your fixed monthly debt expenses by your gross monthly income. The final answer of your calculations shuld be a percentage value.

It is recommended that your debt-to-income ratio should be 36% or less. If your ratio is between 37% and 42% then the debt level is high and you are beginning to run the risk of ending up in bad debt. If your ratio is between 43% - 50% then you are in a danger level and by now you should be feeling the pressures of late payments and escalating bad debt. When your debt-to-income ratio reaches 50% or more htey you have excessive debt loans an you may need the services of credit counselors.

Statistics show that the average American household has the the following debt obligations:

Home mortgage and second mortgage
Auto loan
Student loans
3 - 5 credit cards
Retail financing loans and,
Other loans

You need to learn to avoid the debt trap by setting priorities, making a monthly budget, and making disciplined financial decisions like buying cash, resisting instant gratification and saving on groceries. Always do a debt-to-income-ratio every fortnigh or month depending on how often your income comes in. Remember if you have 36% or less debt ratio then you are managing your debt. Aim to pay off your debt and do not incur more debt. Click here for a debt-to-income-ratio calculator.

"Money is a headache, and money is the cure." - Everett Mámor

Comments (15):

Genevieve Says: I calculated my ratio and it stands at 43% although I am coping it is becoming more difficult to honor my payments. I think you're right Kev I better sort myself out fast | 06.10.2007 |

Nick Says: Mine is at 39% although I'm still fine. I guess I need to reduce to 36 or less according to the advice in this post | 06.10.2007 |

Trevor Says: The whole issue of borrowing and America's credit mentality is part of the reason why consumer debt in this country is so high | 06.10.2007 |

John Says: We just need to learn to handle our personal finances better and learn all we can and fight back. Get a whole consumer revenge thing going!! | 06.10.2007 |

Rita Says: As consumers we need to accept also that any changes in the economy even slight affect us more than we think | 06.10.2007 |

Emma Says: I agree that we need to be aware of economy changes and all that but honestly I'm a mother of four, when you are trying to get by believe me paying attention to the economy is easier said than done. Having said that, I think It probably is something that should be given more emphasis on consumer education | 06.10.2007 |

Casey Says: Brining the information to the consumer is great but for you to stay out of bad debt is unfortunately a personal choice | 06.10.2007 |

Nathan Says: Personal choice that's the key. If you really badly want to stay out of debt believe me you will. I am sick of being in debt so I want to get out and stay out | 06.10.2007 |

Eric Says: So what Kev is saying here is that the recommended debt ratio is 36% I think more than half the population is above that which means we've got serious problems and fixing them is easier said than done like Emma stated even with no kids | 06.10.2007 |

Cathie Says: The issue is self discipline. You have to get yourself out of going into debt and it's not easy. Kevin says in his post that he went through it twice. It all depends on the person and I can see that by Kev running this blog there will be no third time for him | 06.10.2007 |

Gina Says: I just paid off both my credit cards and it felt good to cut them up! | 06.10.2007 |

Dave Says: Congrats Gina. I'm still on my way there and this is a good article because I worked out my debt ratio and I see my ratio is at 41%. I didn't know that before today | 06.10.2007 |

Helen Says: Congratulations Gina and now that you are out of debt stay out | 06.10.2007 |

Eddie Says: That's my goal for the end of this year 1. Get out of debt and 2. Stay out of debt and so far I'm working on a self plan to pay off all my debts | 06.10.2007 |

Fred Says: We are the cause of our own financial mess. But thanks for the heads up about debt ratios and calculations Kev | 06.10.2007 |

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