It depends on a few factors. What life stage you’re in, your spending habits, your goals, your job stability, your financial obligations and so on. If you’re like most South Africans, you have debt. Having some debt is fine – having debt can even be healthy if your debt is connected to your goals, like owning a house or building a career. But how much debt is too much?
A quick and easy way to find out how much debt you can handle is by calculating your debt-to-income ratio. Your debt-to-income ratio will help you determine whether you have too much debt and if you can tackle it on your own. It is also a good indicator for whether you will be accepted for credit. Even if you have a great credit score, if you owe too much money you could still be refused.
While having some debt is okay, if the money you owe interferes with your financial goals, you may have a problem. If you can’t put away money for retirement, save for emergencies or pursue a passion because you have too much debt, it’s time to have a serious think about what you can do to get out.
So, how much debt should you have?
Ultimately, there are many answers to the question, but the simple answer is – how much can you afford?
Why should I find out how much debt I have?
You must know how much debt you owe compared to your annual income. To give you a true financial picture, list all your debt into a lump sum and compare that amount to how much you currently make per year. If you owe more than you make, you need to act quickly and get out of debt.
Knowing how much debt your income can handle, will help put your financials in perspective and prevent you from making more unnecessary debt in the future. The last thing you want is to land in a financial disaster.
Being unable to pay for monthly expenses is a clear sign that you are over your head and you need to deal with your debt problem.
How much debt should you have?
Lenders use a formula when determining whether a client has too much debt. They mix all your expenses and income in a formula and out comes something called a debt-to-income ratio. This ratio tells lenders how risky you are as a client. The higher your score the bigger your debt.
The debt-to-income ratio calculates the percentage of debt you have compared to your income. This calculated; Recurring monthly debt ÷ gross monthly income = debt-to-income ratio.
To calculate your debt-to-income ratio add up all your monthly debt repayments. These are things like credit card payments, car loan, student loan, personal loan and you rent/mortgage payment. Take that total figure and divide that by your gross monthly income (income before tax).
Let’s say that your total monthly debt repayment is R4 500 and your gross monthly income is R10 000. The calculation would be R4 500 ÷ R10 000 = 0,45 = 45%.
45% is a high score, indicating that you have too much debt for your income to handle.
Generally, a good debt-to-income ratio is 35% or below. A bad debt-to-income ratio is 40% or higher. If your debt load is 40% of your gross monthly income, you may be in a financial disaster.
If your score is below 20%, you’re in a healthy amount of debt. That doesn’t mean you should go on a shopping spree with your credit card. Rather continue your spending habits as you were.
If you are in a bad financial situation, you should cut back on expenses or increase your income. Do what you can to get out of debt.
How do you maintain a good ratio?
You can divide your income into portions to maintain a good debt-to-income ratio to gain more control of your spending.
The following percentages are calculated from your gross monthly income.
By capping your mortgage/rent to 25% – 30% of your income. You’ll be able to pay off your mortgage comfortably while freeing up more money for other expenses.
If you’re going to take out a student loan, aim to take out a loan relative to 10% of your gross income. The interest on a student loan will haunt you for years, so pay off the loan as soon as possible.
Did you know that a new car loses more than 10% of its value within the first month, after driving it off the lot? That may not sound like a lot, but it adds up over time. Car repayments should be between 5% – 10% of your gross monthly income, and if you can, try and increase that by 20%.
Credit cards are a big concern when it comes to maintaining a good debt-to-income ratio. The smart way of dealing with credit cards is to not have them at all.
Okay, maybe just one credit card… but use it for emergencies only.
A credit card becomes a burden when you’re using it for daily consumption. A credit card can become very useful when you use it for unexpected bills, like car repairs or medical emergencies – but keep it for that only.
If you do use a credit card, be disciplined in your spending and set goals for paying your debt off every month. The golden rule is to always pay more than the minimum repayment.
Tell-tale signs that you’ve got too much debt
- Your debt (credit cards, personal loans etc.) totals more than half of your monthly income.
- Creditors start calling due to missed payments.
- You can’t afford more than the minimum repayment on your debt.
- When lenders start rejecting you for another loan.
- You don’t have an emergency fund because of debt.
- You struggle making it towards the end of the month.
- After paying your creditors you don’t have money left for extras, like movies or eating out.
- You struggle to make debt repayments on time because you don’t have enough to cover all your repayments at once.
Most people believe they are in control of their finances, but sometimes it can become overwhelming. And if it does, seeking financial help may be the best option.
There are some quick fixes that you could use, this generally includes cutting back on expenses or finding another stream of income. But these solutions take a long time to take effect on your financial situation and will only help if you’re not in too deep.
Quick solutions like payday loans, rent-to-own items or loans with a ‘no credit check’ promise should be avoided at all costs. They will only get you into more trouble and increase your overall debt with high interest rates.
If you’re struggling to turn the situation around yourself, turn to professionals who know how to deal with debt. Debt counsellors, like Debt Rescue, have helped thousands of people become debt-free over the past 11 years.
How debt counselling could help you
- Reduce your monthly instalments.
- Debt counselling is a legal process that protects you from creditors.
- The debt counsellor communicates with all your creditors on your behalf.
- Creditors legally can’t contact you for payments anymore.
- Only make one monthly instalment.
- Gain budgeting and money management skills.
Start taking care of your debt today and get your finances back on track. Have enough money to pay your bills on time and buy food. Once your debt has been settled once and for all, you’ll be able to save for retirement or buy your dream home. Stop your debt from holding you back, and start being financially smart.
Get in touch with us today to find out more.