Why You Have Too Much Debt

Except the children, most of us have debts. We might have incurred them because of financing our home, car, education, business and even our regular spending through credit cards. Having a debt to pay is just fine as long as you are really capable to pay it at the right amount and at the right time. It only becomes a financial problem when your debt exceeds you capacity to pay. Thus, we need to take time to determine if we are already having too much debt, identify the reasons why we sunk on that financial obligation, and find an effective solution to manage that kind of situation.

How much debt is too much?
To determine your debt burden or overload, you need to calculate you debt-to-income ratio (DTI). DTI is the percentage of our gross income that goes toward paying our debts. To know if your debt is acceptable or high, simply add up the amount you spend to pay your debts every month, and divide it by your monthly income before tax. Then, multiply the result by 100 to arrive at a percentage. For example, let’s assume you earn a monthly income before tax of $5,000. Let’s also imagine you spend $800 on your monthly house mortgage, $500 on your auto loan, and $400 on your monthly credit card payments. Your debt-to-income ratio will be computed as $1,700 / $5,000 = .34. Multiplying this by 100 will give you a debt-to-income ratio of 34%. This example means that you are spending more than one third of your monthly income in paying your debts. A ratio of less than 30% is ideal, while a ratio of more than 40% is a red flag for a potential financial disaster. Since our example arrives at a ratio of more than 30%, it already indicates a yellow flag and should be given some significant attention.

Why you have too much debt?
Debt overload arises when a person’s debt-to-income ratio exceeds the ideal ratio. Debts that are considered burden come from a person’s inability to manage his debts, which may include failure to make a personal financial planning, organizing and controlling. Debt-to-income ratio has two main factors: debt and income. Thus, the reasons of too much debt lie on these two elements. People incur overloaded debts because of unnecessary expenses as indicated by their excessive use of credit cards. They also don’t strive to increase their earnings to cover their fixed monthly obligations. This can be illustrated by our example above which shows an extra income not sufficient enough to absorb its home mortgage and auto loan monthly payments.

How to manage debt overload?
Managing your debt overload is a practice you should always practice overtime. It should be a continuous process from financial planning, to personal motivation, and to ensuring that the process is effectively executed. Home mortgage and car loan are fixed and basic loans we should pay regularly. However, credit card expenses are variable and can be controlled to reduce them and improve your debt-to-income ratio. There are also other personal expenses which we can trim down such as our entertainment and leisure expenses, traveling expense and other expenditures that are not necessary to our healthy living. To have a favorable ratio of our debt against our income, we also need to increase our earnings. As mentioned earlier, we cannot just control our long-term loans such as home mortgage and auto loan. Hence, we should focus on generating more revenue to warrant an increase in our income. An increase in income means an increase in our production (for businessmen) and increase in our work force (for professionals and employees). Lessening our monthly expenses requires a lot of self-control and patience, while increasing our income requires more hard work and diligence. Without these habits, we cannot get rid of those extra debt burdens.

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