Understanding Debt – How Much Debt Is Considered Too Much

Being debt-free is a welcome relief that increases financial security, provides ample purchasing power, and aids in boosting savings. Unfortunately, managing such a lifestyle can be challenging. This is especially true for those struggling with making debt payments that can lead to suffering from other financial problems, such as failing to save money and borrowing more money to stay afloat. 

Having debt is not necessarily bad, but it can lead to drained savings, avoiding phone calls from bill collectors, and losing sleep over financial worries if it can no longer be safely managed. Use this article as a guide to learn more about debt and know how much debt is too much.

What Is the National Average Debt?

Statistics Canada states that the average Canadian household owes 1.71 dollars for every dollar of disposable income. Gen Xers usually have the most debt because most have children, parents to care for, and loans to pay. On the other hand, boomers have far less debt as most have houses already paid off. Finally, many millennials considerably have less debt than both because most don’t yet have kids and are more likely to be renting.

What Are the Types of Debt?

Debt comes in three types: good, bad, and toxic. Debt is considered good in the eyes of lenders when the interest rate is low or fixed, and the loan is used to purchase something that is expected to grow in value. 

Bad debt has high interest rates and is used to buy items that depreciate over time. Some of its examples are credit cards, auto loans, and personal loans. Toxic debt, such as payday and no-credit-check loans, carry APRs that go as high as 400 percent. 

How Does Credit Scores Affect Debt?

A credit score provides a glimpse of one’s financial health and allows potential lenders to evaluate borrowers. Here are the ways it is affected by debt:

• Customers who make regular payments are offered higher credit limits and more cards by credit card companies and banks.
• The type of debt carried affects the credit score.
• The length of time one has had a credit card, the payment history, its interest rate, and the number of cards can influence loan applications on banks.
• A stable regular income assures lenders of the borrowers’ ability to make timely payments.

What Is the Best Way to Know If a Debt Is Too Much?

Determining the debt-to-income (DTI) ratio is an effective way to know one’s financial health and tell how much debt one is expected to handle reasonably. It is the amount one owes versus the amount one earns. To calculate, simply add up all monthly fixed expenses and divide the total by the net income. The sweet spot is between 35-40 percent. 

Fixed expenses, like monthly mortgage or rent, car payments, and minimum payments on lines of credit, student loans, or credit cards, are factored in. Utilities, gas, groceries, and other variable expenses are generally not included because of their fluidity. 

Conclusion

Debt is caused by spending more than one can afford. It can be caused by various factors, like overuse of credit cards, low income, or poor money management. Excessive debt can cause cash flow problems, affect credit score negatively, and eventually lead to bankruptcy. Fortunately, staying debt-free is possible by being well-informed about debt, understanding how much debt is too much, and seeking help from debt consultants. 

DebtHelpers.ca offers a wide range of debt solutions and consulting services to help all Canadians become debt-free. Schedule a free consultation today.