How much debt is too much?

November 26, 2014

Whether it's a credit purchase here and there, a student loan, a mortgage or a car payment, just about everyone has debt. But how much is too much?

How much debt is too much?

Carrying debt is not in and of itself a bad thing. In fact it can be a very good thing in the sense that some debts are investments in future growth. But there's a limit.

  • While there's no rule set in stone to determine how much debt is too much, there are some helpful general principles you can follow to stay in the clear.

Debt load versus income

As a rule, many banks and other financial institutions say your debt load should not exceed 40 per cent of your pre-tax income.

  • What this means is that, if you add up all of your debt payments, including housing costs, credit card payments, car loans and the like, it should be less than 40 per cent of your income before any tax has been taken off.
  • If you're renting, you should include your rent in this number as housing costs are considered part of your debt load, as they are regular payments that must be made each month.

Total debt versus disposable income

Another way to look at it is to take the entire amount of income you make in a year and compare it with the entire amount that you owe.

  • Economists have said that keeping this number down to approximately 110-120 per cent is preferable.
  • That means that if you make $50,000 per year, you should try not to carry more than $60,000 worth of debt.
  • But this number can be deceptive, as there's obviously a big difference between $60,000 worth of mortgage debt and the same amount of credit card debt.

Which brings us to an important point: all debts are not created equal.

Types of debt

Some debts are good debts. Mortgages and education costs are considered by financial planners to be good, as they ultimately invest in your future.

  • A mortgage will accumulate equity over time, and education will greatly increase your potential earnings over the course of your life.
  • Also, these debts are often lower interest than other debts, making the payments less onerous.

Consumer debt

The less desirable debts are consumer debts. While it's nice to have all the cars and televisions and clothing we want, these things do not ultimately accrue in value or set us up to earn more in the future.

  • Credit card debts, lines of credit and consumer loans are generally best kept to a minimum.

Your means

So, to simplify, live just a bit beyond your means when it comes to mortgages and education, and live well within your means when it comes to everything else.

  • This will ensure you keep your head above water, and make you a more desirable candidate for future loans on things that will get you ahead.
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