Some people struggle with $5,000 dollars in debt. Others can handle $50,000. It’s not the total amount of debt that you owe that signals you have debt problems, it’s your ability to repay your debt that matters; regardless of the size of that debt.
Sure there are some financial ratios that bankers rely on to signal if you have too much debt.
From a lender’s perspective, they often consider you to have too much debt if your monthly payments, including lines of credit, car payments, mortgage payments, and property taxes, exceed 40% of your total household income. This credit or debt capacity is referred to as your total debt service ratio.
To calculate your own ratio, add up all your monthly debt payments (you should include rent if you are a renter) and divide the total by your income. Multiply by 100 to get your percentage. If the resulting calculation is over 40% a bank will likely consider you to have too much debt. With a debt service ratio of over 40%, there is a high risk that you will default on your loan payments.
However, our experience has been that people with a debt service ratio as low as 30% or even 20% can find themselves in financial trouble. The reason for this is often because most people include only their minimum payments when doing the calculation or don’t take into account extra living expenses they may have.
You don’t have to run a bunch of numbers to figure out that you are in over your head. Here is a list of actual consequences of debt that can happen when you carry too much debt. It is important to heed these warning signs, as many are part of the leading causes of bankruptcy.
Top Warning Signs of Debt Problems:
- Feeling stressed and worried – if you think you have too much debt, chances are, you probably do.
- Losing sleep – you likely have too much debt if it keeps you up at night.
- You spend more than you earn each month.
- Debt payments consume more than 20% of your net income.
- You can’t pay your bills on time.
- You’re receiving collection calls and letters.
- You live off of your overdraft and lines of credit.
- Payment of utility bills and housing bills often get behind.
- You’re transferring balances from one line of credit or credit card to another.
- You don’t pay your credit card balances in full each month.
- You don’t save any money at the end of the month because it all goes to interest costs.
- Your wages are being garnished.
- You’ve had subscriptions or utilities cut off for non-payment.
- You don’t open your bills and instead allow them to pile up for fear of the amount.
- You’ve been declined for debt consolidation by your bank because you are a high-risk borrower.
- You hide your debt or spending from your family.
- You can’t get new credit at a reasonable rate, or perhaps at all.
- You’re using cash advances on your credit card to make bill payments.
- You’re carrying more than one payday loan.
- You have no idea how much debt you have.
Rather than looking at how much debt you can carry, it’s better to look at the situation in reverse. How much money do you need to live? Add up all of your living costs, including your rent or mortgage, food, utilities, transportation, and other personal costs. Add in a ‘cushion’ of 10% or so for incidentals you may have missed. Now take that number and divide it by your income. If you need 80% of your income to cover day to day living expenses, your monthly debt payments can’t exceed 20% or you are in the hole.
The result of being in the hole each month is like the pressure building up on the side of a glacier. You will have to turn to more credit to balance your budget. This increases your debt payments, increasing the pressure. This is one of the true dangers of credit cards. Sooner or later something crumbles.
What Should You Do If You Have Too Much Debt?
Your initial steps might be to contact your creditors and collection agents to see if they are willing to work out a payment plan by reducing your payments and or interest rates. If you don’t ask, you’ll never know. Review your personal living costs and see if you can increase your income by working overtime, getting a second job, or selling unused household items to generate additional income. Review all of your expenses and balance your household budget enough to pay off your debts. Credit counselling can help with this process however beware, you will be required to repay your debts in full if you work with a credit counselling agency.
If, however, you can’t pay your bills as they come due, and you’re looking at years of debt repayment (or perhaps never paying off debt at all) then it’s time to consider formal debt relief options.
You may be able to work out a deal with your creditors through a consumer proposal to repay only a portion of what you owe.
For example. Let’s say you owe $25,000 in credit card debts and bank loans. Your creditors may be willing to accept a deal for as little as $145 a month for 60 months.
If you don’t have the income to support a consumer proposal, you may want to consider filing bankruptcy, however, we always view that as a last resort.
Doing nothing is not a solution. Most people who contact us say they wish they had done so sooner. If you are struggling with debt problems, contact one of our Licensed Insolvency Trustees for a free no-obligation consultation. We’ll help you review all these options.