5 Signs You Have Too Much Debt
Americans are no strangers to debt. As MagnifyMoney, a LendingTree subsidiary, reports, the average debt-carrying household owes over $8,600.
Debt is a wealth killer for sure, especially if a good chunk of your income is going toward minimum payments each month instead of your savings account. Carrying a lot of debt can also drag down your credit score, which makes it harder to qualify for your best terms and rates when applying for new financing.
But how much debt is too much? Here are five red flags that you’ve bitten off more than you can chew — and tips for getting a handle on it.
5 Warning signs that you have too much debt
1. You can only afford your minimum payments
Being stuck in a just-pay-the-monthly-minimum cycle is a pretty good indicator that you’re in over your head debt-wise.
“One of the first signs that an individual’s debts are getting out of control isn’t missing a payment, it’s letting an account balance get to the point that they can’t pay it down within three to five months,” Martin Lynch, a certified credit counselor, and director of education at Cambridge Credit Counseling Corp., tells LendingTree.
Paying the bare minimum each month isn’t much of a strategy since you’ll shell out significantly more over the life of the balance, thanks to the interest. Let’s say you have a $3,000 credit card balance with an 18% APR and a $100 minimum payment. If you only pay the minimum, it’ll take you 41 months to eliminate the balance — and you’ll pay over $1,000 in interest.
But if you double your payment to $200, you’ll shave $592 off your interest fees and be debt-free in just 18 months.The numbers get even better if you opt for a 0% introductory balance transfer offer, which we’ll dive into shortly. The main takeaway here is that if your budget doesn’t allow you to accelerate your debt payments beyond the minimum, it’s time to make a plan.
2. Your credit cards are maxed out
One of the most important factors in determining your score is your credit utilization ratio. This highlights exactly how much of your available credit you’re actually using. If you’ve currently maxed out more than 30% of your credit lines, your credit score will take a hit because it suggests that you’re unable to responsibly manage your debt.
Maxing out your cards means you have zero available credit, which will send this ratio through the roof.
It is a teachable moment, though — why are your cards maxed out? Is it to cover basic living expenses like groceries? Have you reached for plastic to cover impulse purchases like unplanned shopping trips or last-minute vacations? These are pretty good indicators that you’re living beyond your means.
The good news is that creating a solid budget can prevent you from going further into the red. In the meantime, Lynch suggests pressing pause on new credit purchases until you regain control of your finances.
“If you find yourself in a deepening hole, stop digging!” he says.
3. Your debt-to-income ratio is above 36%
Interest rates aside, you can also determine if you have too much debt simply by looking at how your total monthly payments relate to your income. This is aptly known as your debt-to-income (DTI) ratio. To figure it out, add up all your monthly minimum payments and then divide that total by your gross monthly income. What you’re left with is your DTI — 36% or less is the ideal situation.
When it comes to applying for new financing, a high DTI can come back to bite you — especially if you’re applying for a home loan. If a new housing payment would put your DTI at 43% or higher, it sets off alarm bells to most mortgage lenders. Even if you have no intention of buying a home anytime soon, your debt-to-income ratio is still a great way to take your financial temperature. If it’s on the high side, treat it like a warning sign.
4. Your interest fees exceed 20% of your income
Diana Bacon, a Dallas-based certified financial planner, and senior wealth adviser says figuring out if you have too much debt is as easy as crunching a few numbers. Begin by tallying up how much you’re paying in interest charges across all your debt, from auto loans to student debt to credit card bills. If it’s more than 20% of your monthly take-home pay, you’re in trouble.
“If we’re talking exclusively about credit card debt, that number should be well below 20% because those interest rates are just so high,” she tells LendingTree.
Let’s say you earn $2,700 a month and your debt looks something like this:
In this scenario, you’re shelling out $450 each month in interest alone. Dividing that number by $2,700 shows us that these fees represent 17% of your monthly take-home pay, which is awfully close to Bacon’s 20% rule. Translation: it’s time to start prioritizing your debt.
Pro tip: Buy yourself time to pay off credit debt by looking for a 0% intro balance transfer card. These cards offer you 0% APR for a certain period of time, and, depending on your approved card limit, you can potentially shift balances from several cards onto one. That makes it easier to stay on top of payments as well. Check out other ways to consolidate your credit debt here.
5. You’re struggling to build an emergency fund
“Cash savings is the best way to avoid the credit card cycle,” says Bacon, who suggests setting a target that’s equal to at least three months’ worth of expenses.
This should keep your head above water if you’re hit with an unexpected job loss or bill, but building an emergency fund doesn’t happen overnight. It’s a gradual process that instantly becomes harder if a large chunk of your income is going toward debt payments.
But you can only stretch your money so far — unfortunately, this only strengthens the debt cycle. If you have no emergency fund and you’re hit with, say, a $600 car repair, you’ll end up turning to a credit card to see you through. One bright spot, though: you don’t have to choose between paying off debt and building your emergency fund. It’s possible to do both if you leverage the right strategies. Be that as it may, if account balances are a hurdle between you and a healthy savings account, that’s a major red flag.
How to finally get a handle on your debt
Create a realistic budget
It’s never too late to supercharge your budget. If this isn’t your strong suit, take heart — it doesn’t have to be complicated. The idea is to get a firm grasp on two things: your income and your expenses. During a typical month, how much money is coming in and how much is going out?
“A good budget isn’t a cudgel that prevents you from doing what you like to do,” says Lynch. “On the contrary, a budget is the tool that will help you preserve your lifestyle.”
Your debit and credit card statements make tracking your spending relatively easy. From there, you can plug the numbers into a budgeting app or opt for an old-school Excel spreadsheet — whatever feels easiest for you. Either way, you should notice your expenses fitting into one of three categories: regular bills, fun money and goals.
Debt payments are considered regular bills, and our insiders say that no more than half of your take-home pay should go into this bucket. Running on the high side? Meal planning or negotiating down fixed expenses like your cable bill, cell phone plan or credit card interest rates are easy ways to shave a little off the top.
One other note: don’t forget about non-monthly bills. These are budget-busting expenses that pop up at odd times throughout the year, like an insurance premium that’s due every six months. One way to prepare is to jot down all of these irregular bills, including big annual expenses like projected holiday spending. Add them all up, divide the totals by 12, then add these as individual line items on your monthly budget.
Saving $1,000 for next year’s vacation is much easier when it’s broken down into an $84 monthly bill. Doing this also makes you much less likely to reach for a credit card. Bacon says another way to tackle it is to really focus on saving for these expenses for a few months, then loosen up your budget.
Find ways to boost your income
If reducing your expenses is one side of the coin, upping your income is the other. If you’re unable to reasonably cut anything else from your budget, and a pay raise isn’t in your future, any extra cash you bring in on the side can be thrown at your debt. A 2017 CareerBuilder report found that 32% of U.S. workers already embrace side hustles. Apps like Lyft, Uber, and Etsy have certainly made drumming up extra income a whole lot easier.
You can also up your earnings selling things you no longer need. From traditional garage sales to digital options like thredUp, Poshmark and Decluttr, offloading old clothes and unwanted items could help you get out of debt faster. When it comes to the best-selling items on the internet, Statistic Brain reports that women’s clothing, books, tech items and toys come in on top.
Pick the right debt payoff strategy
You can slash your debt repayment timeline and save money by picking the right payoff strategy. Doing nothing more than making the minimum payments will have you chained to your debt for much longer. You’ll also pay way more in interest over the life of the balance.
One of the most popular ways to tackle your outstanding balances is something called the snowball method. This method has you continue making the minimum payments on all your debts — except for the one with the lowest balance, which you hit with all the disposable income you can muster. Once that bill is wiped out, you roll that payment over to the next smallest balance, repeating the process until all your balances are down to zero.
An alternative method is what’s known as the avalanche method. It’s identical to the snowball except that instead of prioritizing your lowest balance, you zero in on whichever balance has the highest interest rate. Both approaches have their pros and cons. Generally speaking, the avalanche method will save you the most money, but staying motivated can be tough if you’re chipping away at high balances.
“If the accounts with the biggest interest rates have a much larger balance, you’re not going to see that instant gratification of those balances really dropping,” says Bacon.
With the snowball method, on the other hand, you’re closing out accounts at a quicker pace, providing boosts of inspiration along the way. Of course, you may end up paying more overall.
Regardless of how you pay off your debt, it all begins with getting a firm grasp on what it all actually looks like. Start by listing out all your balances, including the minimum payments and interest rates.
“What’s important is what works for you,” adds Bacon. “It’s better to pay a little more interest in the short run to become debt-free in the long run.”
Save money with a debt consolidation loan
Most lenders don’t let you borrow money for free, but you can cushion the blow of high-interest rates by consolidating your debts. If you can snag a 0% introductory balance transfer offer, you can hit your debt hard while enjoying an interest-free promo period. (These days, this typically lasts anywhere from 12 to 21 months.) This option will likely involve a balance transfer fee, generally to the tune of 0% to 4%, but the interest savings may be well worth it. One important thing to remember, however: once that introductory period ends, the regular interest rate will kick in, which is why it’s vital to pay off the balance within that time period.
If you’re battling large balances, opting for a personal loan might make more sense — if you go with one that has a lower interest rate than your current balances. Personal loans translate to you receiving a lump sum of money that you can then use to pay off all your debt. (FYI, this may come with a 0% to 6% origination fee.) From there, you’ll have one monthly payment with a fixed interest rate. Another perk here is that this move lowers your credit utilization ratio, which should improve your credit score over the long haul.
Consider credit counseling
If you’ve tried everything and still feel overwhelmed by debt, a credit counseling agency might help you get on the right track. The right counselor can create what’s called a debt management program, which consolidates all your payments into one monthly bill that you pay directly to the agency. Your counselor may also be able to negotiate down fees and interest rates so that you can knock down your principal balances faster.
“Most nonprofit counselors will go through your budget with you for free, without being judgmental,” says Lynch.
He adds that 5% to 7% of his agency’s debt management plan clients pay no fees throughout their enrollment, which typically lasts 48 months. Another 25% end up paying reduced fees.
A debt management plan is ideal for those who are struggling to make minimum payments, despite bringing in an adequate income. Whether you enroll in a formal plan or not, a credit counselor can also assess your financial situation and offer advice for getting on stronger ground. It’s wise to do your homework ahead of time to see if the agency charges a fee for this financial review session.
One other note: steer clear of debt relief firms, which are different from nonprofit credit counseling agencies and have a reputation for being predatory. For-profit agencies also aren’t obligated to provide financial education; nonprofits are.
Things to remember
Debt can sneak up on you, so be on the lookout for red flags. Some biggies include paying interest fees that exceed 20% of your income, having a high debt-to-income ratio, and having more “bad” debt than “good.” Maxing out your credit cards, skating by on the minimum payments, and struggling to build an emergency fund are other warning signs you have too much debt.
The good news is that it’s never too late to pull yourself out of the hole. Creating a realistic budget, curbing your overspending, and upping your income can work wonders. From there, it’s all about choosing the debt repayment strategy that works for you.
“Just don’t take it so far that you get into a scarcity mindset, because that’s when you kind of go crazy,” warns Bacon.
“Let yourself have little bitty treats as you go on so that you never really feel deprived, but you’re still making a lot of progress.”