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How Much is Too Much Debt?
By Nicole Symon MONEY RESEARCH COLLECTIVE
If you’re struggling with your finances, you may wonder — how much debt is too much? This guide will help you determine if you have too much debt and develop strategies for reducing it.
What is considered a lot of debt?
What’s considered too much debt is relative and varies by person based on the financial situation. There’s no specific definition of “a lot of debt” — $10,000 might be a high amount of debt to one person, for example, but a very manageable debt for someone else.
Calculating your debt-to-income (DTI) ratio gives you a rough idea. Your DTI ratio is a number that financial institutions use to determine your creditworthiness. You can use your ratio to manage your money better, too. Lower DTI ratios are favorable, so if you have a high DTI ratio, you may have too much debt.
Here’s how to calculate DTI:
- Add up your monthly debt payments (your credit card debt, mortgage payment, personal loans, student loans, medical bills and other loans, but don’t count everyday essentials like food and medication).
- Determine your monthly gross income (the amount you make each month before taxes and deductions).
- Divide your monthly debt payments by your monthly gross income and multiply that by 100 to get a percentage.
For example, if you pay $500 toward your credit cards each month, $800 for your student loan and $2,400 for your mortgage, your total monthly debt is $3,700. Say your gross monthly income is $7,000. In that case, your debt-to-income ratio would be 3,700/7,000, or 53%.
The Consumer Financial Protection Bureau (CFPB) recommends that homeowners keep their DTI ratio below 36%, and renters below 15% to 20%. The CFPB also says that a DTI ratio of 43% is the highest you can have to be eligible for a qualified mortgage. If you have a high DTI ratio, lenders will likely be concerned with your ability to pay off more debt.
What is the average American debt amount?
According to Experian’s consumer credit report, the average American holds a total debt balance of $101,915 — including mortgage loans, auto loans and other types of debt. The average mortgage debt amount is $236,443, and the average credit card debt balance is $5,910. Between 2021 and 2022, the average credit card, mortgage, auto loan and personal loan balances went up. Student loan balances dropped slightly.
How to get out of a lot of debt
If you’re trying to reduce your outstanding debts or get out of debt entirely, these are some steps you can take:
Identify the root problem of your financial situation
Start by looking into your financial situation. Did you have to pay for an unforeseen emergency without a sufficient emergency fund? Did you develop poor spending habits and finance your spending with credit? Did you lose your job, or did your income decrease?
Once you identify the root issue, you can address it and ensure it doesn’t land you in too much debt again. In many cases, there isn’t just one factor that leads people to take on too much debt. You may find that several factors contributed to your financial challenges. One by one, try to address these factors.
Write a budget plan (and follow it)
Your next step is to create a budget plan and stick to it. Ensure your budget is realistic while being aggressive toward paying down your debt. In the simplest form, your budget must account for all your income and expenses to help you understand where your money goes each month. Use the budget to determine how much money you can use to pay your monthly debt.
Start by determining your after-tax monthly income (the amount you can spend each month). Next, list all your monthly expenses — such as your housing costs, insurance, groceries, utilities, personal care and entertainment — and the minimum payments on your debts. Some of these expenses are the same every month (fixed expenses), but some likely fluctuate from month to month (variable expenses). You can look at your spending over the last few months to estimate your average monthly amount.
Sort these expenses into essentials, nonessential expenses and debt repayment. You can use the 50/30/20 rule as a guide. This rule says no more than 50% of your income should go to necessities, no more than 30% to nonessential expenses, and at least 20% to savings or debt repayment. Adjust your spending to fit these or other guidelines that work for you.
However you set your budget, make sure you can stick to it long-term.
Find ways to boost your income
If you’re struggling with your loans and feel like you don’t have enough income, you may want to look for ways to increase it. Any income you earn that you can put toward your debt will help you get out of debt faster. Try asking for a raise at work, taking on extra shifts or starting a side hustle to bring in some extra cash.
Don’t go for the minimum payment
Paying only the minimum payments on all your loans is enough to keep your accounts in good standing, but getting out of debt will take much longer this way. You’ll also spend much more on interest over the life of your loans if you only pay the minimum amount. Instead, devote as much money as possible to repay your monthly loans.
Some lenders even offer the option to make an extra monthly payment directly toward paying off your loan’s principal. This option will help you eliminate your debt faster and cheaper if you can.
Reduce your monthly expenses
Wherever possible, look for opportunities to reduce your monthly expenses. Put any money you save on monthly costs toward your loan payments to get out of debt faster.
Look over your expenses from the last few months to check whether you could cut back on or eliminate anything. Retail shopping and dining out are two common areas, for example. Consider negotiating lower prices on your utilities to reduce your monthly expenses further.
Hold off on new debts
Some people think that taking out new loans is the solution when they don’t have enough money to cover monthly bills. While that’s a reasonable temptation, new debt is not the answer. If you’re already struggling with debt, you must avoid taking on new loans. Each new loan will add to your outstanding balance and make it more challenging to become debt-free.
Prioritize your debts with the highest interest rates
Write down all your outstanding debts, including the type of debt, the amount you owe and the applicable interest rate. Rather than randomly making payments on all these loans, you should prioritize your most expensive debts with the highest interest rates.
Loans with higher annual percentage rates (APRs) charge you more interest, meaning they’re more expensive. If you focus on paying off these loans first, you can save on interest fees and have more money to put toward your remaining debts. This is known as the avalanche method for paying off debt.
Look into debt management options
Several debt management programs and options are available to help people with too much debt to handle independently.
Credit counselors
Nonprofit credit counseling agencies assist with your finances, including managing your debt. Your credit counselors work with you to build a budget for tackling your debt and even negotiate with debt collectors on your behalf.
They may set up a debt management plan (DMP), which combines your debts with a lower interest rate. These plans are structured so that you have one monthly payment. If you want to improve your credit score, credit counselors can also help with that.
Debt consolidation loans
When you use a debt consolidation loan, you take out one loan equal to your outstanding balance. This way, all your debts are rolled into one loan with a lower average interest rate. It’s easier to manage your debt with just one monthly payment, and you save on interest fees.
The caveat is that not everyone will qualify for the best debt consolidation loans with lower interest rates. Borrowers with lower credit scores will typically receive higher interest rates. This may defeat the point of the loan.
Debt settlement
Debt settlement involves reaching out to your creditors to reduce or eliminate the amount you owe or lower the interest rate on your debt. You can negotiate with your creditors or pay a debt settlement company to do it for you. The goal is to make your debt more manageable.
Hiring a debt settlement company comes with certain risks. For example, you may face hefty fees and damage to your credit score. It could even lead to your creditor filing a debt collection lawsuit against you. Additionally, the debt management company will likely require you to stop paying your debts while they negotiate with creditors, but this will lead to even more debt. Consider all other options before working with a debt settlement company. If you choose to hire one, be aware of the risks and review the CFPB guidelines.
Consider bankruptcy
If you feel completely overwhelmed by your debt and don’t see a way out, consider filing for bankruptcy. While it will harm your credit score, it can offer a viable solution to your debt.
You can file for Chapter 7 or Chapter 13 bankruptcy regardless of your debt, but generally, it’s not worthwhile if your dischargeable debt is less than $10,000. The costs would likely outweigh the benefits between the legal fees and filing costs, plus the negative consequences of bankruptcy.
If you have more than $10,000 in dischargeable debt and don’t think you can realistically pay it off in the next six months, bankruptcy might be the right option. Make sure you have exhausted all other options first. You can consult with an attorney on the process.
Can you go to jail for having too much debt?
Having too much debt has various negative consequences, but going to jail isn’t one of them. You will not go to jail just because you’re behind on your loan payments, regardless of the loan you took out. If debt collectors threaten you with criminal prosecution for failing to pay off your debts, that’s a sign they aren’t following the law.
Weigh the benefits and risks of all of your options
Managing your money and paying off your loans may sound impossible for someone with a lot of debt. The first step to getting out of a lot of debt is to weigh all of your options. Consider all of the risks and benefits before deciding how you will proceed.
Once you decide how to tackle your debt, make a plan and stick with it. Don’t hesitate to reach out for help from credit counselors or other professionals.