How much debt is actually too much debt?

When one party borrows money from another, they are in debt. It allows the borrower to borrow money with the understanding that it would be paid back at a later date, usually with interest, to the lender. Mortgages, vehicle loans, personal loans, and credit card debt are the most common types of debt.

But how much debt is actually too much debt? How to determine whether you are capable of paying back what you’ve borrowed with due interest on time?

Your debt-to-income ratio is an excellent benchmark to use (DTI). You can use this ratio to compare your debt repayments to your take-home pay.

How to calculate the debt to income ratio?

Write down all of your monthly household debt payments and keep a record of them for future reference. Debt is simply the amount of money due to a lender. Rent and groceries aren't considered debt, thus they're not included in the DTI. Do include credit card debt, vehicle loans, student loans, medical expenses, and any other debt you pay on a regular basis.

Calculate your monthly take-home earnings next (this is your net income). Then, divide the total monthly loan payments by your net monthly income. Almost certainly, your answer will be less than one (such as 0.35 or 0.23). Multiply this amount by 100 to find out what percentage of your income goes towards paying off debt. Ideally, your debt-to-income ratio (DTI) should not exceed 15 to 20 percent of your net income, according to financial experts.

For example, a household with a ₹3500 car payment per month ( ₹3500/ ₹25000 = 0.14 or 14%) and a monthly net income of ₹25000 would have a DTI of 14 per cent ( ₹3500/ ₹25000 = 0.14 or 14%). In other words, the ₹3500 in debt is equal to 14 percent of the ₹25000 monthly salary.

READ MORE: How to use credit cards efficiently without falling in a debt trap?

How to use the DTI ratio?

Because it tells you how much debt you currently have and how much more you may comfortably take on, the DTI is a highly valuable tool to have around. You can also utilise the information to come up with a plan on how to pay off your debts in the future.

Be sure to consult this formula before making a new purchase with borrowed funds! It may be prudent to wait to purchase a new item until your net income increases or your total monthly debt payment decreases if, for example, an additional Rs. 500 in monthly credit card payments will push you over the 20 per cent DTI threshold.

Be mindful of the fact that not all debt is negative. Student loans are an example of a type of debt that is necessary for some people. To avoid getting into more debt than you can handle, you must be a prudent borrower. Make sure you know what your DTI is before you borrow money or buy something on credit.