Do you have too much debt? Understanding your debt and getting help

Key takeaways

• You could be facing a debt problem if over 15 percent of your monthly gross income goes towards paying your non-mortgage debts.

• Relying on credit to pay for everyday expenses, consistently only making minimum payments, not having savings and increasing balances are all warning signs of having too much debt.

• Credit counseling, debt consolidation and debt settlement could make debt repayment easier and help you rebuild your financial health.

More than half of U.S. adults (52 percent) report that money has a negative impact on their mental health. Of those, 47 percent say being in debt is one of the leading causes of this negative impact.

Unfortunately, debt is so common that sometimes people underestimate it. It might be normal to have thousands of dollars of debt in your name. In fact, the average U.S. consumer carries over $23,000 worth of non-mortgage debt.  Still, it’s not healthy for your finances.

Understanding the warning signs of having too much debt can help you avoid future financial headaches and lead to a more stress-free life.

How to know if you have too much debt

One of the quickest ways to find out whether debt is becoming an issue is to calculate your debt-to-income ratio or DTI. Your DTI is a measure of how much debt you have relative to your monthly gross income, and it is expressed as a percentage.

You can calculate this manually by adding up all of your monthly debt payments that appear in your credit report — auto loans, personal loans, student loans, credit cards and mortgages, among others — and dividing that amount by your monthly gross income.

Money tip:You can use a calculator to find your exact DTI instead of crunching numbers manually. Using a calculator is also the best way to reduce any room for error.

Typically, lenders like to see a DTI under 36 percent. So, if your monthly gross income is $3,000, that means your monthly debt payments shouldn’t exceed $1,050.

Warning signs your debt could be a problem

Greg McBride, Bankrate chief financial analyst, says that one simple way of knowing if your debt is becoming a problem is if your total balances are going up every month instead of coming down.

“If you’re continually adding to your debt rather than making consistent progress on paying down the balances, you’re headed down the wrong path financially,” McBride says. Another clear red flag that you may be carrying too much debt, according to McBride, is if your total payments for non-mortgage debt exceed 15 percent of your monthly gross income.

Assuming a monthly gross income of $3,000, your credit cards, auto loan, and other non-mortgage debt payments shouldn’t exceed $450 a month when combined.

Other signs that may indicate a debt problem include:

• Not remembering how much you owe and to who off the top of your head.

• Borrowing money to make payments on other debts.

• Relying on credit cards to make everyday purchases.

• Making only the minimum payment due on your cards.

• Not having an emergency fund and are unable to establish one.

• Not being able to contribute to your retirement savings.

Good vs. bad debt

While there are many different kinds of debt, not all debt is considered equal in the eyes of lenders.

Good debt

Good debt increases your net worth over time or has lasting value. Examples of good types of debt include mortgages and student loans. Houses generally appreciate over time and are considered a good investment because if you sell, you may get back more than you put in. Additionally, a college degree enables you to get a well-paying job and earn more money throughout your life.

Bad debt

Bad debt, on the other hand, doesn’t provide any type of value. It includes things you finance because you don’t have the cash to pay for them. Unlike good debt, it doesn’t add to your net worth or have lasting value. Bad debt includes credit cards (if carrying a balance), auto loans and payday loans.

Why does high debt matter?

Having too much debt, particularly bad debt, suggests that you may be living beyond your means. This can make you seem like a riskier borrower in the eyes of lenders, as this makes you more likely to default than someone with a reasonable amount of debt.

“Too much debt, and the wrong kind of debt, will stand in the way of making financial progress,” McBride says.

“You won’t be saving for retirement or emergencies to the extent you should. Your credit rating will suffer if you’re increasingly indebted, limiting your ability to get better interest rates, impacting your auto insurance premiums, ability to rent an apartment, or even to get certain jobs.”

What to do if you have too much debt

If your debt is affecting your day-to-day life, you may want to consider the following options.

• DIY approach

  The DIY approach can be a good option if most of your debt is in the form of credit cards. You can use two main payoff strategies when pursuing this route: the snowball or the avalanche.
  
  The snowball payoff strategy consists of making a list of all your debts and paying them in ascending order. In other words, you will concentrate on paying the one with the smallest balance first — regardless of its interest rate — and move up from there. On the other hand, the avalanche payoff strategy focuses on paying off the account with the highest interest rate first — regardless of its balance — to save more money down the line.
  
  Although both will require a budget recalibration on your end to make it work, the snowball strategy is better suited for those with multiple accounts with the same interest rate. Conversely, the avalanche strategy may be better for those whose accounts have significantly different interest rates.

• Credit counseling

  If the DIY approach isn’t for you or if you’re juggling an overwhelming amount of debt, credit counseling is another low-cost alternative you can explore. You can get these services through non-profit organizations, banks, credit unions and some churches. In some cases, these entities may even offer these services for free.
  
  “If you need help budgeting and managing your debts, contact a non-profit credit counseling agency. They have trained counselors that can help map out a budget, get on a debt repayment plan, and even negotiate with creditors,” McBride says.

• Debt consolidation loan

  One thing you might consider is a debt consolidation loan. A debt consolidation loan essentially bundles multiple debts into a single account with a fixed repayment term and monthly payment.
  Though taking out a loan to get out of debt may seem counterproductive, as you’re basically moving debt from one place to another, it may be worth it in some cases. This is especially true if you have several thousands in credit card debt or other unsecured debts, such as high-interest personal loans.
  
  That’s because these loans tend to have much lower interest rates than most credit cards, plus the fixed rate will protect you against market fluctuations. To qualify for a debt consolidation loan with a reasonable rate, you’ll need a credit score in the mid-600s or above, along with strong financials or a cosigner that meets these criteria.
  
  Likewise, you’ll need to work on addressing any negative financial behaviors that led to your indebtedness in the first place for this strategy to work. Otherwise, you may end up in a worse position than before.

• Debt settlement program

  Depending on your debt’s total amount and type, you can enroll in a debt settlement program through a debt relief company.
  Debt settlement involves negotiating with creditors to get them to settle your balance for less than what you owe in exchange for a fee. Typically, you’ll need to be behind on payments for this to work, which inevitably will cause a drop in your credit score.
  
  There’s also the possibility that the company won’t be able to settle all your debts, leaving you with a damaged credit score, plus financially liable for any late fees assessed by your creditors. That’s why this option should only be considered if your only option is filing for bankruptcy.