How Do I Know If I Have Too Much Debt?

It wasn’t so long ago that it was almost impossible to have too much consumer debt because no one would lend you money you couldn’t afford to repay. Over the last generation, however, that changed. Credit card companies figured out that they could develop loyal customers early by issuing credit cards to college students—people with no income. It only got worse from there.

In 2008, virtually everyone with too much debt figured it out. Credit dried up, asset prices withered, and consumers filed for bankruptcy in unprecedented numbers.

As the economy recovers and credit becomes available again, you need to protect yourself from borrowing too much.
The first sign that you have too much debt is when you have to use one credit card to pay off the balance on other one. I was a young married, twenty-plus years ago when I first saw “I pay my Visa with my Mastercard” on a bumper sticker. For many, this has been a financial planning tool.

(Let’s be clear, in many, many ways it is better to pay your obligations with borrowed money than not to pay, but let it be a clear warning sign that you are in too deep.)

Bankers use the word “fungible” to describe money’s interchangeability. One crumpled old dollar is worth the same and can be used just like three quarters, a dime and three nickels, just the same as a one-dollar charge on your credit card or a one-dollar withdrawal from the bank. It all works the same.

One implication of this is that you may not even realize that you are paying your Visa with your Mastercard! If you charge virtually everything as so many of us do each month and your credit card balances are rising, you are effectively borrowing money each month, you are effectively borrowing the money to make your credit card payments—even if you don’t literally use one card to pay another.

In the U.S., the tax code is progressive, meaning that the more you earn, the greater percentage of your income goes to taxes. The less you earn, the greater percentage of your income is spent on necessities. One thing tends to hold constant for virtually all households. Only 40% of your income can be allocated to debt payments, including housing. If the total of your monthly debt payments, including rent, is greater than 40% of your income you likely can’t afford to make all of your payments and you’re borrowing more every month to make ends meet.

Add up all of your monthly payments, including rent, but excluding utilities. When you divide that total by the gross amount of your paycheck, is the result less that 40%? If not, you likely have too much debt and should immediately develop a plan to cut the balances down to size.

Be careful not to go too easy on yourself. It is relatively easy to find cheaper sources of money that can be repaid over longer periods of time, but that is a sure way to add to your problems in the long term. Instead, focus on paying off your debts one at a time, starting with the littlest ones first!