How much debt is too much?

In a nutshell

Excessive debt can hold you back financially, but a modest amount of "good debt" can be a strategic financial tool. The key is to know your limits, because too much consumer debt can overwhelm your finances and limit your options.

• Whether it’s considered “good” debt or “bad” debt, all debt is a sum of money you have to repay eventually.
• Using some key financial best practices, you can gauge your debt levels and avoid overspending.
• There are several warning signs of unmanageable debt, including high credit card balances, a low credit score and being unable to cover regular living expenses.

What is good debt?

Some people like to categorize debt as either “good” or “bad.” This is subjective, of course, but “good” debt usually means debt used as an investment vehicle. Examples of good debt might be student loans because you’re investing in your education. When you graduate college with a degree, you can land a higher-paying job and pay off your student loans.

Another example of good debt is a mortgage because homes generally appreciate in value over time, meaning you’ll build wealth through home equity. You can also deduct mortgage interest on your taxes each year to reduce your taxable income.

Whether debt is deemed “good” or “bad”, you still need to repay it no matter what. Failure to make debt payments on time can result in late fees or your account being sent to collections, both of which can lower your credit score.

Even too much “good” debt can have negative consequences. For example, if you borrow too much to attend college, you may not be able to afford to repay the loans later.

Using the 28/36 rule

The 28/36 rule is a financial rule of thumb that advises you to spend no more than 28% of your gross monthly income on housing, and no more than 36% on your total monthly debts.

Maintaining this rule can help keep your monthly debt obligations manageable and leave you with enough room in your budget to afford other living expenses — while also being able to save and invest.

Here’s an example: Let's say you have a gross monthly income of $6,000. Based on the 28/36 rule, your total housing costs should not exceed $1,680 per month (6,000 x 0.28) and your total debts shouldn’t exceed $2,160 per month (6,000 x 0.36).

So if you already have a mortgage payment of $1,650 and a car loan payment of $300, you should be cautious about taking on any additional monthly debt payments that exceed $200.

Understanding debt-to-income (DTI) ratio

Your debt-to-income (DTI) ratio is a measure of how much of your gross monthly income (before taxes) goes towards monthly debt payments. Lenders use this to evaluate your ability to repay a loan. The lower the percentage, the better.

Lenders prefer to see a DTI of 43% or less for mortgage borrowers, however, some loan programs allow for a DTI as high as 50%. If your DTI is significantly higher, it may be a sign that you have too much debt, making you a higher-risk borrower who may be more likely to default on your loans.

What are warning signs of too much debt?

If you’re regularly making late payments, can't save money or if you’re using credit cards to cover living expenses without paying off the bill each month, this could be a red flag that you have too much debt.

Also, if you’re constantly stressed about your debt and struggling to make ends meet, it may be a sign that you’re struggling with money. Having too much debt can make you feel stuck financially, but the good news is you can always turn things around with a plan and consistency.

Related: How to pay off credit card debt fast

Here are some steps to take to get out of debt:

• Start by tracking your expenses and identifying where your money is going each month. Having an awareness of what you’re spending versus what you bring in is the first step to getting your debt under control.
• Then, create a budget and see where you can cut back on spending, such as eating out, unused subscriptions or shopping around for cheaper services.
• Next, prioritize your debt payments. The debt snowball method involves paying off smaller account balances more quickly while making minimum payments on other accounts. On the other hand, the debt avalanche method prioritizes paying off debts with the highest interest rates first.

How does debt consolidation work?

Another strategy is to consolidate your debts into one loan with a lower interest rate. This can make it easier to manage and potentially save you money in the long run. Also, consider reaching out to creditors and negotiating for lower interest rates or a revised payment plan.

Stick to your budget and avoid taking on new debt while you pay down your existing debt.

Average debt levels by category

So how much debt do people have on average? Knowing this can help you determine if you have an above or below-average debt level.

The data below for each debt category is from Experian’s Consumer Debt Study.

Housing

Consumers have an average of $244,498 in mortgage debt. Mortgage debt is common since homes are expensive, and most people need to take out a mortgage to buy a home.

When you apply for a mortgage, your lender will preapprove you to borrow up to a specific amount. You don’t need to borrow the maximum amount if you feel the monthly payments could stretch your budget. Only you can decide if your mortgage payment fits comfortably within your monthly budget with your other monthly expenses.

Related: How to get a mortgage

Car loans

The average auto loan balance is $23,792, but the average car payment has risen from $500 to $700 depending on whether you buy a new or used car. Even if your car payment is on the lower end, around $350 for example, this amount can add up, especially if you have two car payments in your household.

Related: Average car loan interest rates by credit score

A good rule of thumb for auto loan debt is the 20/4/7 rule. According to this rule, you should put 20% down, set a term for no more than four years and limit your monthly auto loan payment to 7% or less of your income.

Student loans

Borrowers with student loans carry an average loan amount of $38,787. Student loan debt may be considered “good debt,” but it can still be hard to manage when you leave school and have to cover your payments, along with other living expenses.

A general rule of thumb is to borrow no more than you can expect to earn as your starting salary a few years out of college. However, this is not always an option for everyone, depending on your career path.

Sometimes, it makes sense to look into refinancing your student loans. If you have private loans, this could be an option if you can lock in a lower interest rate. With federal student loans, however, refinancing means getting a new private loan and losing relief benefits, such as deferment, forbearance and student loan forgiveness.

In many cases, it’s best to keep federal student loans where they are since the interest rates are generally lower than private student loans.

Related: Guide to student loans

Personal loans

The average personal loan balance is $19,402. A personal loan can come in handy when you need money fast for an immediate expense. However, make sure you can afford the minimum payment each month and pay the balance off by the agreed-upon term. Most lenders prefer a DTI of 36% or less to approve you for a loan. Consider reducing your overall debt to meet this requirement before applying.

Personal loans typically have repayment terms that range from 12 to 60 months. Building an emergency fund can provide a cash cushion and help you avoid taking out too many personal loans. Set regular automatic transfers to your savings account to build up your emergency savings.

Related: Best personal loans

The AP Buyline roundup

It’s easy to accumulate what might feel like too much debt. But it’s not impossible to get out of debt or avoid taking on more debt than you can handle. Financial rules of thumb — like the 28/36 rule and being mindful of your DTI ratio — can be helpful.

Consider your personal budget, income and financial goals to determine how much debt you can comfortably manage. It’s okay to wait and save up cash for certain purchases to avoid overspending.

Frequently asked questions (FAQs)

At what age should you be debt-free?

Everyone’s situation is different; there’s no set age when you should be debt-free. The earlier you focus on repaying debt and reducing your spending, the sooner you can become debt-free.

How rare is it to be debt-free?

Around 23% of Americans are debt-free. While it’s common to have debt, not having debt is also attainable. People who don’t have debt tend to live within their means, limit unnecessary spending and avoid taking out loans.

Do billionaires use debt?

Billionaires often use debt strategically to maintain their standard of living without needing to liquidate their assets and to make investments that can grow their wealth. However, they tend to avoid consumer debt.