How Much Debt Is OK?

How much debt can you reasonably carry? One useful rule of thumb is that monthly payments on consumer debt should be no more than 20 percent of monthly disposable income (income after subtracting mortgage or rent, food, utilities, and taxes). Another guideline is that the total outstanding consumer debt should be less than one-third of your annual disposable income. The important point is that you must carefully plan for consumer debt as one component of a monthly budget that includes adequate provisions for regular savings and an emergency reserve.

Stop sign: Using credit to finance routine purchases or to splurge on extras is a sure sign of personal financial mismanagement.

Debt Payment Guideline Example

A family that occupies government quarters has after-tax take-home pay of approximately $2,500 per month. If the family has no utilities or other housing expenses, it is only necessary to estimate a spending plan for food. Let's assume that the family's food costs are $500 per month. This means that the family has $2,000 a month in disposable income, or income not spent. According to this guideline, installment debt payments should not exceed $400 per month (20 percent of $2,000). How much debt could the family carry for $400 per month? If the debt had an average maturity of three years, $400 would be adequate to service about $12,000.

Total Debt Guideline Example

This rule is a bit stricter than the debt payment guideline. Continuing with our example, the family living in government quarters with an annual disposable income of $24,000 should not owe more than one-third, or $8,000, in consumer debt. Either method of figuring will provide a ballpark figure for the maximum debt you should carry.