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.