How much debt is too much?
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.
"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
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
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