How to Tell If You Have Too Much Debt

Credit card with dollars

In most cases, any amount of debt is too much. But with weak job growth, stagnate wages and a drop in consumer confidence, credit card debt has climbed its highest level since November 2007.

New statistics show that more consumers turned to credit cards for purchases as revolving debt rose by $8 billion, increasing the total credit card debt to $870 billion, according to the Federal Reserve.

The problem with credit card debt is that it can quickly spiral out of control: as the debt burden increases, so do monthly payments and the amount owed continues to pile up. With just a few big charges, a credit card bill that was once affordable is suddenly out of your control.

If you are facing credit card debt, don’t wait until you are struggling to address the issue. If you notice credit card bills growing, realize it and start keeping better track of your spending and look for ways to cut back and reduce spending.  You need a good way to keep tabs on your debt burden to ensure you’re not headed down a road of financial distress. This is where a personal debt-to-income ratio can come in handy.

A debt-to-income ratio provides an accurate gauge of your financial standing and calculates how your debt level relates to your given income level. What counts as a manageable level of debt for one person may be too much for another person with less income.

To calculate your debt-to-income ratio, first add up your total monthly income. This can include wages from you and your partner, child support, alimony payments, veteran’s benefits, pension benefits and any government assistance you receive. Next, total up your monthly obligations: mortgage or rent payments, car payments, student loan payments, credit card payments, other debt obligations and your monthly bills and utilities. Divide your monthly debt total by your monthly income total and the multiply that number by 100 to determine you debt-to-income ratio.

Once you have the number, the next step is to use it to gauge your current financial standing. The following ratios provide an indication of where you are financially:

Your debt-to-income ratio less than 36%. You are in good financial standing. Keep your debt at this level and look to building your savings and making investments to improve your financial outlook.

Your debt-to-income ratio is between 37% and 42%. This is an acceptable amount of debt, but you should still look for ways to reduce your debt burden so you can free up money for savings and investments. If possible, create a plan to pay more than the minimum amounts required on your credit card bills to reduce your debt faster.

Your debt-to-income ratio is between 43% and 49%. This range means you are verging on financial distress and need to take immediate action to get your finances under control. You may wish to consider options for consolidating your debt, such as balance transfers or debt consolidation loans to pay off the outstanding debt.

Your debt-to-income ratio is 50% or more. You are in financial distress and should seek help. With this high of a debt-to-income ratio, you will not be able to build and maintain a healthy financial outlook. Contact a financial planner or credit counseling agency to review your situation and discuss options for debt relief.

If your ratio is significantly higher than 50%, don’t panic. You are not alone. Many Americans are spending more money than they bring in each month and try to survive on credit or take out payday loans and cash advances. Some economists consider borrowing a positive sign for the economy, but it can also mean people are borrowing to make ends meet.

Here are tips for paying off credit card debt:

Pay more than monthly minimum. Strive to pay more the than just the minimum on bills. Any amount paid over the minimum goes directly towards the balance owed and pays down debt faster and reduces money lost to interest.

Set priorities.  Making a list of priorities helps consumers to focus on saving money for important goals. Consider whether a summer trip would jeopardize the purchase of a house.

Avoid accumulating debt. Now is not the time to apply for new credit cards or loans. Focus on paying off current debt. It’s difficult to get out of debt when new debt is mounting. Use cash for purchases rather than credit.

Pay off high interest rate debt first. The most efficient way to resolve debt is by paying down the highest interest rate balances first. Once you have eliminated the debt with the highest rate, work your way down based on interest rates, but continue paying the minimum due on all other debts.

Howard Dvorkin, CPA, is the founder of Consolidated Credit Counseling Services, Inc., and the author of Credit Hell: How To Dig Out of Debt. He is also personal finance expert and consumer advocate who has been helping people for more than 15 years.