How much debt is okay? - 2011
Rosemary K. Heins
University of Minnesota Extension Educator
Credit is the use of borrowed money for a price, which is called interest. This creates debt which needs to be repaid. Not all debt is bad since people need to use credit for major purchases such as a house or the cost of higher education. But we need to be smart borrowers.
How can we determine if we are getting ourselves into a too a much debt situation? A good benchmark to use is to calculate your debt-to-net income ratio. Lets review how this is calculated.
Start by making a list of your monthly household debt payments. Do not include the home mortgage payment but list credit cards, auto loans, student loans, medical bills or any other debt you are making a monthly payment on.
Next calculate your monthly take-home pay or net Income. Once you have these two figures, divide the total debt payments per month by the net income. You’ll obtain a percentage that financial experts like to see at no more than 15-20 percent. For example a family with a $250 car payment and $100 of monthly credit card payments and $2,500 net income per month would have a debt-to-net income ratio of 14 percent. The $350 of debt is 14 percent of the $2,500 monthly income.
Use this formula before deciding whether to take on a new credit purchase, like a new car or a new computer. Do the calculations using what the anticipated loan payment would be. Ask yourself, does adding this bill keep me in a safe borrowing debt to net income zone? Remember the total debt borrowing zone for most people is considered to be 15 to 20 percent of net pay.