Having too much debt can cause financial problems, which in turn causes more stress, anxiety, panic and fear. Most people have some form of debt, but how much is ok. There are different forms in which one could have a loan. For example, a mortgage, an auto loan, a student loan, and through credit cards. As long as one is taking care of the debts and taking steps to pay it off, there is nothing to fear. But it becomes bad when one does not have a financial control. Therefore it is essential to determine if one is having too much debt or not. Although, there are several ways of figuring out the debt, the most important formula that everybody uses is the debt-to-income ratio. This gives an idea of how much debt one has relative to his/her income. One can calculate this for both good and bad debt, while it is recommended to focus on the bad ones.

Good Vs Bad Debt

A debt is considered a "Good" debt when it is incurred to purchase something that will appreciate in value and can contribute to overall financial status.

Example: (a) Mortgage Loan: A home purchase with a reasonable mortgage loan can be considered to be a good debt. As homes appreciate in value, the mortgage loan one takes to pay for the home is considered an investment.

(b) Student Loan: A student loan to finance a college education. Obtaining a college degree usually means that one can make more money over their lifetime.

A debt is considered a "Bad" debt when one uses debt to finance things that can be consumed. In this case they are not accumulating good debt. This debt creates financial problems.

Example: (a) Credit card debt is often considered the main source for bad debt because of the nature of items that credit cards are used to purchase.

(b) Debt used to finance a vacation, a vacation does not appreciate in value, therefore don't go for a vacation one cannot afford.

Debt-to-income Ratio

The debt-to-income ratio is a straight forward formula which is obtained by adding the amount one spends monthly divided by the total monthly income. Convert this number to percentage by multiplying by 100. This result is the debt-to-income ratio.

Example: Let say some one is making $4,000 a month and they spend $500 on credit card payments and $350 on an auto loan. Their ratio calculation would be $850 divided by $5,000, which is equal to 0.17. Multiply that by 100 for a debt-income-ratio of 17%. In this case one spends a quarter of their income on bad debt.

The lower the debt one has, the better it is. A bad debt ratio above 8-10% is considered too high and often is a sign that one is overloaded with debt.

For considering both good and bad debt, the best is for income-to-debt ratio being below 36%. A ratio lower than 30% is considered excellent, while a ratio over 40% is an indication for a potential financial disaster.

If you or someone you know is in high debt, debt settlement companies like us can help to manage your finances and eliminate debt completely.