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How much debt is too much?

Debt is like hot sauce -- fine in small doses, but too much is playing with fire. The challenge is to figure out just how much is too much.

A good rule of thumb: Your debt load, excluding your home, should not exceed 20 percent of your take-home pay, says Bill Hampel, chief economist for the Credit Union National Association, a trade organization.

He advises consumers to include second mortgages and home equity loans in the mix when they measure their debt load using the 20-percent rule. The reason is simple: While a first mortgage is an investment in property that, in most cases, is appreciating in value, second mortgages, in many cases, are simply the homeowner's attempt to pay off unsecured debt, like credit cards.

And that doesn't mean if your debt percentage is in the high teens, you're on easy street. Instead, picture your debt load as a traffic light, going from green to yellow to red.

"If it starts getting over 15 percent, it's something to be concerned about," Hampel says.

And, just like Tabasco, each person's tolerance for debt might be slightly different. Some credit counselors advise keeping debt to 10 percent. Others see clients who can handle a little more.

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"Upper income people have more access to credit," says Hampel, "but they have more ability to pay it off."

Someone with a higher salary might be in a position to take on a higher percentage "because there's more discretionary income," says Rus Halsey, group manager and counselor for GreenPath Debt Solutions, a nonprofit credit counseling service based in Farmington Hills, Mich.

But even high rollers have to be careful.

"There are not many circumstances in which being above 20 percent is a good thing," says Hampel.

Many times, it's a matter of degree. By looking at charge-off statistics, Hampel estimates that roughly 10 percent of households are in serious trouble with debt.

"But that doesn't mean the other 90 percent are managing their money incredibly wisely," he says.

If you think you might be heading for financial trouble, there is no magic solution, just good old common sense. Track your spending and make a budget. Lock up the credit cards and pay cash. When you limit your spending, use some for bills -- and bank some for yourself.

Here are some of the warning signs that you might be piling up too much debt:

You can't pay off the bill in full each month. The purpose of credit is to shift when you pay for something or, as in the case of a vacation, to make it easy to pay for purchases without carrying large amounts of cash -- not to start running a tab you can't pay.

"If I'm spending more than I can pay, then I haven't planned very well," says Mark Oleson, director of the Financial Counseling Clinic at Iowa State University.

Even before you get to the stage where you're only paying the minimum, there are warning signs. If you rarely see your credit card balance drop to zero, you need to start rethinking your spending/saving plan. Everyone has a financial crisis now and then.

"If you're two months past an event -- medical bills or car problems - and it will take you a while to pay it off, that's fine," says Hampel. "But if, absent any major event, you find your balance is growing, that's a problem."

You're charging because you haven't got the money. "If you make a purchase with a credit card because you can't afford to pay cash for it," that's a strong sign you're in trouble financially, says Ric Edelman, author of The Truth About Money.

You're near or at the limit with your credit cards. "That tells you you have spent yourself into a corner, and the credit you need to buy for everyday life is not there," says Chris Bender, communications manager for the National Foundation for Credit Counseling, the umbrella organization for the nation's largest network of nonprofit credit counseling centers.

You're suffering physically. "Anxiety is healthy," says Edelman. "It shows the brain is recognizing that your spending patterns are in conflict with your income. The problem is for many people that indebtedness doesn't bother them."

But many folks feel the pain and just don't know what to do.

"If you [consistently] dread getting the mail or answering the phone or if you get a little sweaty before you open a bill, you've got a problem," says Bender.

When you start getting anxious, listen to your gut.

"It's time to throw the credit cards away and focus their energies on paying off the credit," says Edelman. "It's time to stop the bleeding."

If you can't make a budget or draft a plan on your own, contact the NFCC for a referral to a credit counselor in your area.

You're fighting with your spouse or family over money. "If [married couples] are arguing about finances, you know that there's a problem there," says Oleson. Likewise, if bills are weighing on your mind when you're at work or at play, maybe it's time to put together a plan for saving some money and deep-sixing the debt.

You're running up unsecured lines of credit. Many institutions offer lines of credit or overdraft protection on checking or savings accounts. "But if that account starts staying significant month to month, that's an issue," says Hampel. Such services are meant to help with short-term liquidity issues, he says. But once you've used them up, you don't have that safety net.

You're living paycheck to paycheck. "Over half our clients are in that position," says Halsey, a certified consumer credit counselor. "They say 'I don't know which bill to pay first.'"

If you or your spouse lost your job, you'd be in financial hot water. This is another indication that you're living month to month, and a sign that you have no savings as a reserve, says Bender. Likewise, if you're constantly borrowing from friends or family. The solution: Build up that saving account.

All you can pay are the minimums. Whether you make $25,000 or $250,000, this is a sure sign of financial trouble. "We've seen clients with credit card debt that exceeds $100,000," says Halsey. "They're taking on credit cards to pay credit cards."

He remembers one couple, a lawyer and spouse, who were in that exact position. "It can happen to anybody," Halsey says. "It's very easy to get into that pattern."

You're using future money to pay current bills. What's worse than living month to month? How about borrowing from next month's income to pay last month's bills. "Using future money to pay current bills -- that's the way a lot of people live," says Oleson. "They have no savings." It's also a pretty good sign that you're in over your head.

You're always in a jam financially. "If it seems like you've always been in a financial crisis, it seems like there's always something," says Halsey, then you're definitely over and above your debt comfort zone. Scale back and build some savings.

You're considering a consolidation loan because making the monthly payments is a struggle. Too many times, says Oleson, clients come in asking for a loan but don't really understand the concept. "They know there's some sort of answer ... they know it's supposed to fix it," he says.

You're denied credit -- or asked to obtain a co-signer. If you have established credit and now creditors don't think you have enough money to repay them, chances are you don't.

Dana Dratch is a freelance writer based in Atlanta.

-- Posted: Jan. 9, 2003

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