Our Guide to Understanding How Much Debt Is Healthy?

Love Debt Free guide to understanding how much debt is healthy
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When appropriately managed, borrowing money can help to improve your financial situation by allowing you to investing in assets we could otherwise not afford. Although it might seem strange, being in debt has the power to make you wealthier in the long run.

But while most of us know the risks of taking on too much debt, it is nearly unavoidable to live without it in the modern world. Besides, can’t some debt be a good thing?

All things in moderation’ is a maxim which any borrower would do well to remember before taking on credit; nobody ever wants to find themselves trapped under a mounting avalanche of debt.

In this article, you’ll find information on industry standards and guidelines that could help you determine how much debt is healthy for you.

We look at the warning signs lenders look for before parting with their cash, the difference between good and bad debt, and some red flags that could signal you’re overloaded with debt.

How Much Debt Is Too Much?

It is nearly impossible to define where the line is between having debt and having too much debt because everyone manages their finances differently.

However, one calculation which can help work out how close to you are to having unhealthy levels of debt is your debt-to-income ratio (DTI). Before any responsible lender agrees to loan you money, they will examine your credit report and work out your DTI ratio to assess whether you can afford to repay any new debts.

Your credit report is your financial footprint; it contains information about all of the loans and accounts you have held in the recent past.

By looking at it, a lender can see how much money you currently owe on everything from store cards to mortgages, and how much you pay every month to service these debts.

Your Debt-to-Income Ratio

Your debt-to-income ratio is the percentage of your income goes towards paying off debts.

For example, if you earn £2500 a month and you spend £850 on your mortgage, credit card and other debts, your debt-to-income ratio would be 34%.

As a rule of thumb, a debt-to-income ratio below 35% is considered healthy. Some lenders might be willing to loan money to people with a ratio of up to 45%, but this is the upper limit of what is considered manageable, healthy levels of debt.   

To work out your debt-to-income, add up all of your debt repayments and divide this number by your gross monthly income. Multiply the resulting number by one hundred to find your ratio.

Although it might be possible to get by with slightly higher levels of debt, your debt-to-income ratio is a useful tool for checking in on your financial health; if banks are unwilling to invest in you, there is a good chance that you’re holding risky levels of debt.

Average Debt-to-Income Ratio of UK Households

YearDebt-to-Income Ratio*+/- Over ‘Healthy’ 35% ratio
2008147%+112
2009145%+110
2010142%+107
2011139%+104
2012135%+100
2013132%+97
2014127%+92
2015126%+91
2016124%+89
2017127%+92
2018126%+91
2019125%+90
* Rounded to the nearest integer. Source: Office of National Statistics

What Is the Most I Should Borrow?

If you’re thinking of taking out a new loan, you should be thinking about how you’re going to pay it back. By working out how much debt you can afford to pay each month, you should get an idea of how much you can afford to borrow and how much interest you can afford to pay, which will make shopping for a good deal much easier.

Conventional wisdom says to borrow as little as you can afford to, and pay it back as quickly as you can. This will save you money on interest fees over the long run, help you avoid excess debt, and enable you to get debt-free sooner.

Besides these simple guidelines, you could use your debt-to-income ratio to work out what is a safe level of debt for you to hold according to your income. If your new debt would take your DTI ratio from 20% to 50%, it’s probably too much.

How Much Should I Borrow for My Mortgage?

For mortgage shoppers, there is a more detailed calculation which can help you work out how much mortgage you can afford. The ‘28-36 rule’ is a ratio which looks at your monthly income versus your expenditure on a mortgage and other debts. It is designed to keep your debt-to-income ratio in check while maximising the money you can invest in bricks-and-mortar.

According to the rule, you should spend no more than 28% of your income on mortgage payments, inclusive of fee s and taxes. Your total expenditure on debts, of all kinds, should not exceed 36% of your income (or an extra 8% on top of your mortgage).

For example, if you earned £2000 per month, the maximum you should spend on your mortgage is £560, leaving £160 for other debts.

If you paid £560 per month on a 25-year mortgage with 4% interest, the most you could afford to borrow following the 28-36 rule is £111,860.

Did you know?
The average adult in the UK owes £4264 in unsecured debt
12.8million UK households have less than £1500 in savings
The average UK household owes £60,363
Pre-COVID-19 forecasts estimated this will rise to £86,388 by 2023
In February 2019, over 200 people a day contacted citizens advice with debt problem s
Source: The Money Charity

Good Debt vs Bad Debt

It’s not just the quantity of debt you hold which important; the type of debt matters too. Does your debt promise to enrich you over time, or is it just a drain on your resources?

Holding debts of the right kind can help you improve your credit score and ultimately lead towards greater financial freedom.

Good debt is a debt which:

  • Allows you to make investments that will enhance your living standards in the future

A mortgage, personal loan for home improvements, or student loan, could all be examples of good debt.

  • Has affordable payment terms

Even if you borrow to improve your prospects, if the debt is unaffordable, it is not a healthy debt. Unaffordable payment terms can jeopardize your financial stability, undermining any investments made with the credit.

  • Is the cheapest way to borrow

Even if your debt is currently affordable, it is always better to minimize the interest and fees paid on your borrowing.

Holding the wrong kind of debt can usher all kind of stress into your life, and in extreme situations can lead to financial ruin.

Bad debts are those which:

  • Drain your wealth

At the end of the debt, you won’t have much to show for it, and the debt will have cost more than the returns. Bad debts do not make you better off or help to improve your prospects.

Examples include borrowing to pay bills or purchase extravagant items which will quickly depreciate in value

  • You can’t afford to repay

Any debt which you would struggle to repay is bad debt. Even with great terms and a low-interest rate, if the debt stretches your budget to breaking point, it’s a risk.

  • Are more expensive than other borrowing options available to you

If your debt is costing you more than it has to, it is eating into any potential returns from the investments you make with your credit.

Tell-Tale Signs You Could Have a Debt Problem

If you’re asking yourself whether you have too much debt already, there is a good chance you do.

However, there is a difference between being having a slightly overstretched budget and being in the midst of a debt crisis.

If you recognize any of the following, you could have a debt problem:

  • You ignore bills, phone calls and emails because you’re worried they could be remaining you about your arrears
  • You’re borrowing to pay off other debts (this is different to consolidating your debt, where you take out a new loan to move all your debts to one place)
  • You debts are causing you so much stress that it is affecting your work life, relationships and mental health. You could be feeling anxious, struggling to sleep or turning to alcohol or drugs to escape thoughts of your mounting debt.
  • You rely on credit for your day-to-day expenses

If any of these sound familiar, you could have a debt problem on your hands.

Although it can feel like you are trapped in an endless cycle of debt, with the right help, it is possible to break free. Debt counsellors and debt charities exist to help people with problem debt.

A debt professional can work with you to help organize your debts and may negotiate with your creditors to reduce your payments to an affordable level.

How Can Love Debt Free Help?

Here at Love Debt Free, we have partnered with some of the UK’s leading Debt help companies.

They have already helped thousands of people reduce and manage their debts, and they can do the same for you.

Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.

If you would like to speak to one of these debt help companies, click on the below and answer the questions.

Len Burgess
Len Burgess
Len Burgess is a successful digital entrepreneur and founder of LBLK Publishing which specialises in Financial content. Len has been writing professionally on financial and business topics for 5 years before starting Love Debt Free.
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