Debt is a tool that many of us will use to achieve our financial goals, whether it be buying a house, an investment property or investing in a business. However, like many things in life, too much of anything can be detrimental over the long term. The fact is that your circumstances are unique. The amount of debt your family can manage depends on a myriad of factors. Whether you choose to navigate your position autonomously, or via the support of an adviser, taking time to understand your situation is essential.
So, how much debt is too much debt? Here are four tools you can use to help answer that question.
Metric 1: Debt to income ratio
One way to assess how much debt is too much is to look at your To calculate your debt-to-income ratio, you will need to add up your total credit or debt balances and divide it by your total gross annual income (your salary or total annualised income each year before tax and other deductions are taken out). Generally, households should spend no more than 36% of their income on debt overall. When measuring your DTI, 3.0 or below is seen as excellent, the maximum from Australia’s four big banks being between 7.0 – 8.0.
Metric 2: Interest rates
In addition to your DTI, another important factor to consider is the interest rate on the debt. If you have high-interest debt, such as credit card debt, it may be wise to pay it down as quickly as possible to avoid accruing significant interest payments over time. You may be in a financial position where you can secure lower interest rates, however, it’s still important to ensure that your decisions will safeguard you against any uncertainty in the future.
Metric 3: Is it good or bad debt?
Debt doesn’t always need to be a dirty word. We know that some debt is seen as good. While not black and white, good debt is typically categorised as anything that might bring you long-term gain such as property, business, or education. Good debt is usually the assets that are likely to appreciate over time and are seen as a wise investment. In contrast, ‘bad debt’ is defined as money borrowed to purchase depreciating assets or assets for consumption. Bad debt is often described as high credit card debt, automotive and personal loans. The key lies in being strategic about what debt you take on and knowing if it has the potential to benefit your financial future.
All in all, the key to managing debt levels is to take a holistic view of your financial decision. This means considering your income, expenses, assets, liabilities and long-term goals, making informed decisions about how much debt you can comfortably afford without compromising your financial position.
Whether you go it alone or engage an adviser, the assurance that comes with sleeping easy at night knowing your financial house is in order is invaluable. Reach out if you would like to understand the possibilities for managing your debt in a responsible, sustainable and holistic way.