How Much Debt Should I Have?
As Founder of a service dedicated to helping people deal with debt, I’m often asked how much debt people “should” have. It’s a tough answer, because it depends on the type of debt and also how old you are. To illustrate, consider the following situations: paying 20% of your income to mortgage is much different than paying 20% to your credit card. And trying to pay off credit card debt when you’re 30 is different than if you’re 65, retired, and on a fixed income.
Let’s start by looking at a couple different viewpoints. First, if you’re getting close to retirement, you should have no debt payments. In retirement, most people have to live on fixed income and debt payments will eat into that fixed income, sometimes leaving little left for enjoying the “golden years”. Although this clearly applies to consumer debt, we extend it to auto and mortgage loans as well. You should do everything in your power to pay off all your debts, including your mortgage, by age 65 to give you maximum financial security and the best likelihood of a happy retirement.
The second viewpoint is the industry standard “Debt to Income” ratios. This ratio, often called DTI, is a measure of your borrowing “capacity” or how much debt you can support with your income. Because it was designed by lenders, it’s really a measure used to determine how much they can lend you without before you take on so much debt that you’re a default risk.
So with the caveat that DTI isn’t designed as to indicate how much debt you should have, here are two measurements that lenders use with DTI:
- Front End DTI: This is a measure of housing costs (mortgage, mortgage insurance, and HOA fees). Most lenders want you to have a front-end DTI less than 28% of your total income.
- Back End DTI: This is a measure of your front-end DTI plus credit card, student loans, auto loans / leases, and other loan payments. Lenders want this measure to be less than 36% of your total income.
Note that the Back-End DTI doesn’t specifically say what your other loan payments should be as a percentage of your income, but most experts suggest that you not pay more than 12% of your income toward student loans, auto loans, and credit cards.
However, remember our first point — that all debt payments should really be approaching zero as you near retirement and pay them off. So although you may have DTI metrics less than the 28/36 guideline, that doesn’t really mean you have a “healthy” level of debt if you’re close to retirement.
I know this can be confusing. That’s why we developed a simple tool at DebtScore.com that will calculate and grade your debt ratios by type of debt depending on your age and income. It’s not a perfect tool, but it will help you understand how much debt might be appropriate for your individual situation.