How much debt is too much is a hotly-debated topic. Some types of debt can actually be good for your financial health–and some are very bad.
In this show Laura and Kate discuss 7 warning signs that show you’ve crossed the line into bad debt and need to get on a better path.
Richer Life Lab show quote
“Buy what thou hast no need of, and before long thou shalt sell thy necessaries.” -Benjamin Franklin
How Much Debt Is Too Much?
The majority of us have some amount of debt, like a mortgage, car loan, student loan or credit cards. Most people need to leverage some amount of debt to buy a home, car, get an advanced education, or to start a business.
Not all debts are bad! Debt is a powerful tool that can actually help you build wealth—when used the right way.
The trick is to know which types and how much debt is good for your financial health–and which ones can take you down a bad path of reckless financial behavior. Too much debt puts unnecessary strain on your finances that keeps you from building an emergency fund, investing for the future, and reaching your financial goals.
Interested in how we have come to live with so much stuff, and how it’s changed the course of history? Kate mentions an interesting book to check out: Empire of Things: How We Became a World of Consumers, from the Fifteenth Century to the Twenty-First.
The golden rule for debt? Never go into debt for anything that doesn’t give you a return—like consumer goods, dining out or fancy vacations. Only go into debt when:
- you’re confident that you’ll receive a return on your investment
- you have steady income or ample savings to make payments
- you qualify for a competitive interest rate
Here are 7 warning signs that indicate you may have too much debt that could jeopardize your financial future:
Warning sign #1: You don’t know what you owe
If you don’t know how much debt you have or their approximate balances, you need a reality check ASAP!
Create a spreadsheet listing each debt account name, number, interest rate, and amount owed. Even if someone else (e.g., spouse or partner) manages the finances, you should always be aware of your assets and debts.
I generally recommend that you tackle debt in order of the highest interest rates first. However, if you have a small, low-rate debt that you really want to disappear, making small progress can keep you stay motivated.
Warning sign #2: You’ve been turned down for credit
If you’ve recently been denied credit, you probably have poor credit. That can be the result of one or many factors, such as having late payments, judgments, liens, too little credit history… or too much debt.
Lenders have different guidelines for how much debt is acceptable. For instance, when applying for a mortgage, a rule of thumb is that the total of all your debts, including the mortgage payment, generally shouldn’t add up to more than 35% to 40% of your gross income.
Warning sign #3: Your credit cards are maxed out
If you’re using credit cards to satisfy a shopping habit or to buy necessities during a financial rough patch, you’ll eventually hit your credit limit. A maxed out card hurts your credit and may cause you to incur fees if a purchase exceeds your credit limit.
So stop making charges or taking expensive cash advances on maxed out cards. and start making payments that are higher than the monthly minimum.
Also see: Best Tips to Improve Your Credit Score
Warning sign #4: You don’t have savings
Without any savings, you’re living on the edge financially speaking! Any unexpected expense could send you into a tailspin that causes you to go further into debt.
Make a plan to radically cut your expenses. Begin setting aside as much as possible each month in a bank savings account.
Warning sign #5: You overdraw your bank account
Most people at some point have overdrawn on their bank account and bounced a check. But it should never happen regularly.
If you’re paying expensive non-sufficient funds (NSF) fees on a regular basis, it’s probably because you’re spending more than you make.
The solution is to create a budget so you know what your expenses are and how much you earn. Then cut back on variable expenses that change from month to month, like groceries, dining out and entertainment.
Warning sign #6: You don’t pay bills on time
If you’re not paying bills on time, it’s likely that your finances are a mess and you don’t want to face them. Ignoring bills may make you feel better in the short term, but we promise that they’ll come back to bite you in the form of late fees and bad credit.
Contact your creditors to discuss any financial hardship and ask for their help. You may be able to work out a payment plan to get caught up with past due balances or have late fees waived.
Warning sign #7: You lie about your finances
If you’re lying to family or friends about your spending habits or how much debt you have, it’s because you know deep down that there’s a serious problem.
Take action! Create and stick to a realistic budget.
If you share finances with someone else, like a spouse or partner, talking about your debt can be the first step to getting a handle on it.
You can also make an appointment with a financial planner or see a debt counselor. If you’re in the U.S., the National Foundation for Credit Counseling at nfcc.org is a great resource.
Richer Life Lab Podcast practical
This week’s Richer Life Lab practical is to take a really close look at your debt. List out how much you owe and the interest rates you’re paying. Remember that your high interest debts that don’t come with tax advantages—like credit cards—are typically the ones you should to pay off first.
Have you struggled with debt or found a strategy that helped you pay off a large amount of consumer debt? We want to hear about what’s working for you! Let us know if you try out one of the strategies we suggested in the show or have other recommendations that we can share with listeners in a future show.
Send us a Lab Report to firstname.lastname@example.org or record a voice message on this page. You can delete and re-record your message if you need to.
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