Most Americans haveÂ credit card debtÂ and will die withÂ credit card debt. It’s one of the most accessible types of credit there is, becoming available as soon as you’re financially independent. It’s also one of the most damaging, as tooÂ muchÂ credit card debtÂ could hurt yourÂ credit report, reduce yourÂ credit score, and cost you thousands of dollars in interest payments.
But how much debt is too much? What is the averageÂ total debtÂ for American consumers and households and when do you know if you have crossed a line?
HowÂ MuchÂ Credit Card DebtÂ is too Much?
TheÂ averageÂ credit card debtÂ in the United States is around $5,000 to $6,000 per consumer. However, this doesn’t paint a complete picture as these figures don’t differentiate rolling balances. In other words, even if you repay your balance in full every month, that balance will still be recorded as debt until it is repaid.
For many consumers, $6,000 is not “too much”. It’s a manageable sum that they can afford to clear. However, if you’re out of work, relying on government handouts and have no money to your name, that $6,000 can seem like an unscalable mountain. And that’s an important point to note, because everything is relative.
To the average American, unsecured debt of $50,000 is catastrophic. It’s the sort of debt that will cause you to lose sleep, stress every minute of the day, and panic every time your lender sends you a letter. To a multi-millionaire homeowner who runs several successful businesses, it’s nothing, an insignificant debt they could repay in full without a second thought.
One man’s pocket change is another man’s fortune, so we can’t place an actual figure on what constitutes “too much debt”. However, this is something that credit reporting agencies, creditors, and lenders already take into consideration and to get around this issue, they use something known as aÂ debt-to-income ratio.
YourÂ Debt-to-Income RatioÂ (DTI)
YourÂ DTIÂ can tell you whether you haveÂ too much debt, and this is true forÂ credit card debtÂ and all other forms of debt (student loans,Â car loans,Â personal loans, and even mortgages).Â
DTI is not used to calculate yourÂ credit scoreÂ and won’t appear on yourÂ credit report, but it is used by mortgage lenders and other big lenders to determine your creditworthiness and if you don’t past the test then you won’t get the money.
To calculate yourÂ DTI, simply calculate theÂ amount of debtÂ payments that you have and compare this to yourÂ grossÂ monthly income. For instance, let’s imagine that you make $400 inÂ credit card paymentsÂ and $600 inÂ autoÂ loanÂ payments, creating aÂ total debtÂ payment of $1,000. YourÂ grossÂ monthly incomeÂ is $4,000 and you don’t have any investments.
In this scenario, yourÂ DTIÂ would be 25%. as yourÂ monthly debt paymentsÂ ($1,000) are 25% of yourÂ monthly income. If you have a $1,000Â mortgage paymentÂ to make every month, your obligations increase and yourÂ DTIÂ hits 50%, which is when you should start being concerned.
Many lenders will not accept you if you have aÂ DTIÂ greater than 50%, because they are not convinced you will make your payments. $2,000 may seem like a lot of money to have leftover at the end of the month, but not when you factor tax, insurance, food, bills, and everyday expenses into the equation.
If yourÂ DTIÂ is below 50%, you may be safe, but it all depends on those additional expenses.
How to Tell If You’ve Borrowed Too Much
YourÂ debt-to-income ratioÂ is a good starting point to determine if you have borrowed too much, and if it’s higher than 50%, there’s a good chance you have borrowed more than you should or, at the very least, you are teetering on the edge. However, even if yourÂ DTIÂ is above 30%, which many consider the ideal limit, you may have tooÂ muchÂ credit card debt.
In such cases, you need to look for the followingÂ warning signs:
You Can’t Pay More Than the Minimum
Minimum paymentsÂ cover a substantial amount of interest and only a small amount of the actual principal. If you’re only paying the minimum, you’re barely scratching the surface and it could take years to repay the debt. If you genuinely don’t have the extra funds to pay more money, then you definitely have aÂ debt problem.
YourÂ Credit Card BalanceÂ Keeps Growing
The only thing worse than not being able to pay more than the balance is being forced to keep using that card, in which case the balance will keep growing and theÂ interest chargesÂ will keep accumulating. This is a dire situation to be in and means you have far tooÂ muchÂ credit card debt.
Your Debt is Increasing as YourÂ Take-Home PayÂ is Reducing
If yourÂ credit card billÂ seems to be going in the opposite direction as your paycheck, you could have a serious problem on your hands. You may be forced to takeÂ payday loans; in which case you’ll be stuck repaying these on top of your mountingÂ credit card interest,Â reaching a point when your debt eventually exceeds your disposable income.
You Don’t Have Savings or anÂ Emergency Fund
A savings account orÂ emergency fundÂ is your safety net. If you reach a point where you feel like you can no longer meet theÂ monthly payments, you can tap into these accounts and use the funds to bail you out. If you don’t have that option, things are looking decidedly bleaker for you.
Dangers of Having TooÂ MuchÂ Credit Card Debt
The biggest issue with excessiveÂ credit card debtÂ is that it has a habit of sticking around for years. Many debtors only make theÂ minimumÂ monthly payment, either because they can’t look at the bigger picture or simply can’t afford to pay more.Â
When this happens, a $1,000 debt could cost them over $2,000 to repay, which means they’ll have less money to their name. What’s more, thatÂ credit card debtÂ could impact theirÂ credit score, thus reducing their chances of getting low-interest credit and of acquiring mortgages andÂ auto loans.
It’s a cycle. You use a credit card to make big purchases and are hit with a high-interest rate. That interest takes your disposable income away, thus making it more likely you will need to use the card again for other big purchases.Â
All the while, yourÂ credit utilization ratioÂ (calculated by comparingÂ available creditÂ toÂ total debtÂ and used to calculate 30% of yourÂ credit score) is plummeting and your hopes of getting aÂ lowerÂ interest rateÂ diminish.
What to do if you Have tooÂ MuchÂ Credit Card Debt?
If you find yourself ticking off the boxes above and you have a sinking feeling as you realize that everything we’re describing perfectly represents your situation, then fear not, as there are a multitude of ways you can dig yourself out of this hole:
Credit counselorsÂ can help to find flaws in your budget and your planning and provide some much-needed insight into your situation. They areÂ personal financeÂ experts and have dealt with countlessÂ consumer debtÂ issues over the years, so donât assume they can only tell you what you already know and always look toÂ credit counselingÂ as a first step.
Credit card companiesÂ charge a higherÂ annual percentage rateÂ to consumers with poorÂ credit scoresÂ as they are more likely to default, which means they need those extra funds to balance their accounts. Another way they do this is to charge penalty fees, penalty rates, andÂ cash advanceÂ fees, the latter of which can be very damaging to an individual struggling withÂ credit card debt.
Cash advanceÂ fees are charged every time you withdraw money from an ATM, and the rate is often fixed at 3% with a minimum charge of $10. This means that if you withdraw as little as $20, it’ll cost you $10 in charges, as well as additional interest fees.
If theÂ cash flowÂ isn’t there, this can seem like a good option, but it will only make your situation worse and should be avoided at all costs.
UseÂ Debt Relief
Debt management, debt settlement, andÂ debt consolidationÂ can all help you to escape debt, creating aÂ repayment planÂ and clearing everything fromÂ credit card debtÂ toÂ student loanÂ debtÂ in one fell swoop. You don’t even need an excellentÂ credit scoreÂ to do this, as many debt management andÂ debt consolidationÂ companies are aimed towards bad credit borrowers.
AÂ balance transferÂ credit cardÂ moves all of your currentÂ credit card balancesÂ onto a new card, one with aÂ large credit limitÂ and a 0% introductory APR that allows you to swerveÂ interest chargesÂ for the first 6, 12, 15 or 18 months. It’s one of the best options available, assuming you have aÂ credit scoreÂ high enough to get the limit you need.
Monitor Your Situation
Whatever method you choose, it’s important to keep a close eye on your finances to ensure this never happens again. You should never be hit with an unexpected car paymentÂ orÂ mortgage payment, because you know those payments arrive every single month; you should never be surprised that you have interest to pay or that yourÂ credit scoreÂ has taken a hit because of a new account or application.Â
If you paid attention to your financial situation, you wouldn’t be surprised, you would understand where every penny goes, and as a result, you will be better equipped to deal with issues in the future.
How Much Credit Card Debt is too Much? is a post from Pocket Your Dollars.