How much debt is too much debt? | Awkward Money Questions

How much debt is too much debt? Let's find out. Hi, I'm Sarah from NerdWallet and you're watching Awkward Money Questions, where we provide smart and comforting answers to your most uncomfortable money question. So sit back and relax and let's dive into today's awkward money question. How much debt is too much debt? So this is a really uncomfortable topic for a lot of people because there's so much shame associated with being in debt. But the reality is debt isn't good or bad. It's not a person. It's simply a financial tool that allows people to pay for big ticket items and then pay those bills off for those items over a long period of time, which allows you to kind of mix payments for really expensive things into your monthly budget in a way that's more realistic and sustainable for you. You're in good company if you're in debt. I mean, so many of us, like myself, have mortgages. People take on debt to buy cars. People take on debt to finish their education. You know, there are so many different reasons why you might need to borrow money. And the important thing is that when you do borrow money, you do it thoughtfully and you think about how likely you are to be able to afford those debt payments every month. And so, you know, just keep in mind that everybody you walk by on the street has probably been in debt at one point or another in their life and might be in debt right now. So you are not alone. When you're starting to think about how you should repay your debt, it's kind of helpful to get a sense of where you are in terms of how financially stressed are you. There's a simple calculation that helps you figure out where you stand, and that's the debt to income ratio. And to find out that number, you simply divide your monthly debt obligation into your monthly pre-tax income. And then you multiply the answer by 100 to get a percentage. And in general, if your number is 40% or higher, it's a sign that you're under quite a bit of financial stress. But you probably already knew that if you were feeling a little bit dicey about your debt. So what can you do about it? Now, there are lots of different debt payoff strategies that we talk about at NerdWallet. One of them is the debt avalanche method. And that's where you make a list of all of your debts and you put them in order from highest interest rate to lowest interest rate. And you make minimum payments on all of your debts every month to keep your credit in good standing. And then any additional cash that you have in your budget, you apply to the principle of the debt with the highest interest rate. And then you keep doing that until you pay off that first debt on the list. And then you move that extra cash and begin applying it to the principle on the debt with second highest interest rate, and so on until you're debt free. Another similar method is snowball, which is kind of the same in that you make a list of your debts. But it's different in that you put your debts in order of lowest balance to highest balance. And then you do the same thing. You make minimum payments on all of those debts. But then you apply extra money to the principle on the debt with the lowest balance and so on until you're debt free also. Now, mathematically speaking, with the debt avalanche method, you will pay a lower amount of interest over time. But for many people, the debt snowball method works better because knocking out that small debt first really quickly provides little psychological motivation that can help you, you know, feel empowered to begin paying off more of the debts on your list. So there's no one right way to tackle debt. But there is a way that might be more right for you. And ultimately, the most important thing is that you really do something to pay off your debt. And anything you do is a move in the right direction. Now, you might be asking, where's extra money supposed to come from in my budget when I don't really know where my money is going? Well, that's where budgeting methods come from. And one of the ones we talk about it in the wall a lot is the 50 3020 budget. 50% of your take home pay goes toward the necessities like your rent or your mortgage payment, groceries, utilities, 30% of your take home pay goes into non essential expenses, the fun stuff, travel, dining out entertainment, and 20% of your take home pay goes toward savings goals and debt repayment. And budgeting gets a bit of a bad rap. It's kind of like having to take your medicine, but really think of it as a way to just plan out your spending. This way, you know where every penny goes. And you know exactly how much you have left over to apply toward your debts when all of your other financial obligations are met. And by planning out your spending in this way, you might even be to quickly identify places where you can cut back, maybe you have subscription services, you no longer use and you can cancel those subscriptions. Maybe you change jobs and your commute got shorter, so you're not really spending much on gas anymore. Or you switch jobs from a company where you had to wear suits every day to one where you could dress casually. So suddenly, your clothes are less expensive and your dry cleaning bills are less expensive. And that frees up money in your budget to now apply toward your debts. So if you would like to employ all of these methods, but you want a little bit of help, nerdwallet.com has great calculators where you can figure out your debt to income ratio, you can plot out your 50, 30, 20 budget, and you can even plot out a couple of different debt repayments scenarios using different debt repayment methods. So ultimately, it's not about whether your debt is too much. It's about whether or not you can sleep at night. And when it comes to your money, really, that is the most important thing. So if you find yourself thinking about your debt, a lot, it's on your mind all the time. Now is the time to do something about it. Because it is so freeing to take control of your debt and feel like you're actually making progress. So you can eventually apply your money toward the things you want to do instead of the things you have to still pay for. Thanks for watching. Make sure you hit that subscribe button so you don't miss out on more answers to your awkward money questions. See you next time.