How to know when your debt is too much

For many of us, our list of outgoings usually feature some sort of debt repayment. It could be the mortgage on our home, a credit card bill or a personal loan. But while we understand debt is an everyday part of life and many of us make repayments without worry, there is a point where it can all become too much.

How much debt is too much?

Only you will know when your debt has become too much. The tell-tale signs are:

• You have a very limited amount of disposable income (or none at all), once debt repayments and major expenses have left your bank account.
• You have missed payments or been late making them.
• You are being chased by a creditor for debt that you are struggling to repay, alongside your other financial commitments.
• Creditors have started adding charges and fees onto your debts.
• You are worried interest rates and charges on debts you are repaying will make the amount you owe – and/or need to pay back every month – unmanageable.
• You are anticipating a change in circumstance which will affect your ability to make regular payments.
  

If you are currently experiencing any of the above situations, it’s likely you have too much debt and it is starting to impact your life. Do not despair though. There are ways to get a handle on things and resolve your debt issue.

To start with, we recommend checking just how much of your monthly income is being spent on debt payments. This can encourage you to do something about the debts you have and put yourself in a better financial position. Below is an explanation on how to do this:

The debt-to-income ratio

This is an easy way of working out how well you are managing your finances, and more importantly, your debt repayments. It is a percentage that tells you how much of your monthly income goes towards paying off your debts.

You may not realise lenders also check your debt-to-income ratio to see if you are capable of keeping up with monthly repayments.

They’ll use the information you provide to determine your debt-to-income ratio percentage and decide whether to offer you a credit product or not. The most common types of lenders to do this are mortgage providers and banks which offer loans.

How to work out your debt-to-income ratio

Working this out is pretty simple. We’ve broken it down into a step-by-step process:

1. Add up how much debt you make payments on every month. Include everything, such as your mortgage, car finance and student loan.
2. Next, work out your monthly income. This should include your net wage – the amount you receive after tax and national insurance has been taken out – as well as any other payments you receive, such as child benefits.
3. Now, it’s time to divide your debt total each month by your income and then multiply this by 100.

Here is the calculation:

Monthly debt payments ÷ monthly income x 100 = your debt-to-income-ratio

Here’s an example:

•   Your monthly debt payments = £950
•   Your monthly income = £1,890

Debt-to-income ratio:

£950 ÷ £1,890 x 100 = 50%

A debt-to-income ratio of 50% would suggest you should look into a way of removing some of this debt. If not it could become unmanageable very quickly, for example, if an emergency situation arises.

What is the ideal debt-to-income ratio?

Most people aim for a debt-to-income ratio of around 35-45%. This suggests you have a decent percentage of your income left to pay the rest of your monthly expenses, as well as enough to maybe put a little away to create a savings buffer for emergency situations.

If the washing machine breaks or the car needs fixing for example, reducing your debt-to-income ratio should ensure you can always manage these unexpected costs.

Lowering this percentage also means you’ll be in a better place to be approved for bigger credit products, such as a mortgage or a home improvement loan – and can even help you decide whether it’s the best time to apply for one of these.

Our budgeting guide provides more detailed information on how to manage your finances. Our team of experts are also on hand to answer any questions you may have about managing debt.