Do I have too much debt?

In a world of mortgages, credit cards, store cards, finance agreements and car financing, debt has become part of everyday life. In fact, in some instances, having some level of debt is a prerequisite if you’re looking to be accepted for credit. However, although debt is now commonplace, too much debt is still problematic. If you’re concerned you may have too much debt, this guide can help you.

Dealing with too much debt

If you already know that your debt levels are too high, you should take immediate action. After all, a number of charities and private companies are available to help you deal with your debt problems.

Sometimes it’s helpful to speak to someone about your issues and come up with a structured plan to manage your debt. And as these reviews for Financial Wellness show, debt management groups aren’t judgemental people and they specialise in finding a way for you to recover financially. There are many ways you can get out of debt and an expert company will be able to advise you. They can help you create:

  • A debt management plan
  • An individual voluntary agreement
  • A debt arrangement scheme

No matter where your debt comes from, if it’s unmanageable then you need to speak to someone. If you believe your debt is still at a manageable level, try taking the following steps to decide whether that’s actually the case.

Look for warning signs

If any of the following warning signs apply to your situation, you may have problematic levels of debt:

  • Your debt balance isn’t decreasing, even though you’re making regular repayments
  • You’re living from payslip to payslip and never have any money left at the end of the month
  • You’re unable to build an emergency fund of £500-£1,000 in case something goes wrong, such as your car breaking down or your boiler failing
  • You’re not contributing to a pension scheme or paying for any insurance because you need the money for everyday expenditure
  • You’re regularly using a credit card or a payday loan to give yourself a cash advance

Work out your debt-to-income ratio

Your debt-to-income ratio (which is also known as your DTI by financial planners) divides your monthly debt payments by your gross monthly income, giving you a percentage. If this percentage is too high, it acts as an indicator that your finances may not be under control.

You can calculate your debt-to-income by:

  • Adding up all of your recurring monthly debts like your mortgage or rent, car loans, child support, credit cards and student loans
  • Adding up your monthly income, including any benefits you receive
  • Dividing your monthly debt by your monthly income and multiplying it by 100

For reference, a debt-to-income ratio of under 20% is considered to be excellent, while a debt-to-income ratio of over 40% is a sign of financial stress. If your ratio is more than 50%, you should seek expert advice immediately. If you’d like a second opinion, try taking the Money Advice Service’s Debt Test.

Categorise your debt

If you decide that your level of debt is manageable but you’d like to reduce it, it’s well worth categorising whether the debt you’re worrying about is ‘good’ debt, ‘bad’ debt or ‘toxic’ debt. This way, you can prioritise making certain payments to improve your financial situation.

What is good debt?

If you have taken out a product over the long term and the interest rate is fixed for the duration of the agreement, this is a form of good debt. Often, products covered by good debt also increase in value over time. Usually, forms of good credit are harder to obtain as providers will carry out credit checks and perform stress tests.

One example of good debt is a mortgage. Although this loan is a form of debt, the interest rate is usually low, and generally speaking, while you’re making your repayments the value of your property rises, too.

What is bad debt?

If you’ve used credit to buy an item you’ve used, or you’ve purchased something that will lose value over the agreement term, this would be considered bad debt. Usually, the interest rate on a line of credit like this is much higher than it would be on a mortgage.

There are lots of examples of bad debt, as it’s a category of credit that includes everything from auto loans, high-interest credit cards where you’re not paying the entire balance each month, and high-interest personal loans that you’ve taken out for a discretionary purchase, such as a new wardrobe or a family holiday.

What is toxic debt?

Toxic debt is even worse than bad debt. It includes things like payday loans and high-interest loans. In extreme circumstances, some of these loans may even cause you to pay more in interest than the item is worth. These loans can limit your cash flow and impact your credit score, so you may no longer be able to access good debt if you’re saving for a house.

Once you’ve categorised your debt into these categories, you’ll be able to see if you have a problem with your debt. After all, fixed-term loans like business loans and mortgages aren’t problematic and, if you can pinpoint examples of bad or toxic credit, you can take steps to eliminate them by prioritising their payment.

Compare your debt to the national average

Once you’ve assessed your debt levels, you should also put your debt into some form of perspective. This is because some level of debt is very common, and as this article from the BBC shows, the average household financial debt is £9,400. This covers personal loans, student loans, hire purchase agreements, credit cards, overdrafts, mail order debts and arrears on bills.

If this data is expanded to include mortgages and other bills, the average debt for each adult in the UK is £31,845, according to Finder. This means that on average, every Brit spent £969 on interest payments alone last year.

After reading this guide, we hope you’ve discovered that your debt levels are more manageable than you first thought. However, if this isn’t the case, you should speak to an expert as soon as possible. They will be best placed to offer you advice and guidance on how you can escape from your debt problems and thrive over the years to come.

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