How much debt is too much?

Learn about debt-to-income ratios and if there truly is good and bad debt

Debt-to-income ratio targets

Now that we’ve defined debt-to-income ratio, let’s figure out what yours means. Generally speaking, a good debt-to-income ratio is anything less than or equal to 36%. Meanwhile, any ratio above 43% is considered too high.

The biggest piece of your DTI ratio pie is bound to be your monthly mortgage payment. The National Foundation for Credit Counseling recommends that the debt-to-income ratio of your mortgage payment be no more than 28%. This is referred to as your front-end DTI ratio. A 28% mortgage debt-to-income ratio would mean the rest of your monthly debt obligations would need to be 8% or less to remain in the “good” category.

How could you lower your debt-to-income ratio?

There are two primary opportunities to lower your DTI ratio: consolidating credit card debt and refinancing student loans.

Consolidating credit card debt could lower your monthly payments and spread repayment over years. Plus, it could save you big-time when it comes to interest since credit cards have much higher interest rates than personal loans or balance transfer credit cards.

Similarly, you could refinance your student loan if your monthly payment is too high. Refinancing allows you to extend the repayment term and therefore lower your monthly payment. Just make sure you’re comfortable with paying more interest over the life of the loan in exchange for this lower payment.

Is DTI ratio the only way to evaluate your debt?

No, it’s not. That’s because your debt-to-income ratio doesn’t take into account other monthly expenses, like groceries, gas, utilities, insurance, and cable/internet.

Do you want to see how debt fits into your bigger picture? Calculate how much leftover cash you have each month by subtracting your monthly debt obligations and other expenses/bills from your after-tax monthly income.

How much is left over? Ideally, you’d have a couple hundred dollars remaining to cover any unexpected expenses and put toward savings goals.

Sure, DTI ratio isn’t perfect, but it’s a good indicator that can help you evaluate your total debt.

Is there good and bad debt?

Yes, but how you define the two terms can differ. You could look at debt in one of two ways:

1. Will borrowing this money make me money someday?
2. Does it make sense to take money out for this reason?

Let’s consider the first perspective, which is the traditional interpretation of the “good or bad” debt question. What debt do you currently have or are considering taking on that could earn you a return on your investment? Your student loan is a good example; that loan helped you get your college degree, which helped you get your job and jumpstart your career. Your income is your return on your investment, hence the “good debt” label.

The same can be said for a mortgage — especially if your home’s value rises by the time you sell it — and any loans used to start a small business.

On the flip side, the traditional definition of “bad debt” is any money taken out to purchase an asset that depreciates in value. This includes auto loans and any goods or services purchased with borrowed money.

However, this thinking is very cut and dry. Consider the second perspective on good and bad debt: Does it make sense for me to borrow this money for this reason?

The answer to that question varies from person to person. For example, using a loan to fund your wedding could be “good debt” to take on if doing so:

1. Helps you hold onto savings to buy a house in the near future, and
2. You have enough free cash flow in your monthly budget to take on the monthly payment.

And one more thing: Don’t take on more debt for the sake of raising your DTI ratio. Yes, you want to show potential lenders your ability to carry and repay debt, but you shouldn’t take on more debt for the sake of getting closer to the 36% number mentioned previously.

What to remember

It’s hard to evaluate debt in a vacuum.

Debt-to-income ratio can be a good indicator, but since it doesn’t factor in your other monthly expenses, it can only tell you so much.

The same goes for the “good or bad debt” debate. It’s up to you to decide if taking on that debt is the best way for you to reach your goals in a financially responsible manner.

More information

Paying down debt could require a helping hand. Schedule a Citizens Checkup at your nearest Citizens Bank branch to get the advice you need.