The debt-to-income ratio is a useful formula to measure your financial health. It is calculated by comparing your monthly debt obligations to your monthly gross income (before tax), expressed as a percentage. Generally, a good debt-to-income ratio is less than or equal to 36%. Anything higher than 43% is considered excessive debt.
Financial advisors often suggest that a DTI greater than 35% means you have too much debt. However, there is no single indicator that debt will ruin your financial health. If your debt payments are higher than your income, it's a sure sign that you have too much debt. This can lead to payment delays and higher interest rates, as well as difficulty in making monthly payments.
It can also limit your cash flow, savings and ability to borrow for important goals such as buying a home. Experts suggest targeting high-interest debt first, then low-interest non-deductible debt, and finally tax-deductible debt. If you can't keep up with payments, or if you're facing stress or sleepless nights, it's probably time to make a plan to pay off your debt or seek debt relief. Another sign of having too much debt is if your credit score starts to decline and you become seen as a high-risk borrower by banks and other lenders.
Having more income freed from debt can mean greater financial confidence, morale, and better opportunities to save for the future. On the other hand, debt negatively affects your credit rating, since 30% of that calculation is based on the amount of debt you have. Crises and emergencies can be difficult to manage if most of your profits go toward debt repayment. Between the warning signs and the debt-to-income ratio, it's important to assess how much debt is too much for you.
If you find yourself unable to make payments or facing financial stress, it may be time to make a plan to pay off your debts or seek help from a financial advisor.
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