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How Much Debt is Too Much?

Subjectively: if you are worried about your debts, then you have too much. Debt is not a necessary evil. It is perfectly possible to live reasonably well without ever borrowing a penny.

For some it is a tenet of faith: neither a lender nor a borrower be.

If you work hard, save prudently and order your priorities appropriately, it is possible to get everything you want out of life by saving and waiting.

Most of us simply choose otherwise.

In which case the first lesson is: learn your comfort zone. Be aware of the very second at which debt starts to nag quietly in the back of the mind. And stop borrowing, start repaying, right there. This isn't rip up the cards timejust put them in a drawer for a while.

But should you actually be worried, or are you overreacting? Is there an objective measure that can help you decide?

You cannot draw a line in absolute figures, or even in percentage of current earnings. Much depends upon future prospects. Are you in a steady job, with relatively fixed income, or are you on the fast-track to the executive floor? Are you in a high-earning but high-risk job that could see you out the door next week, or earning less but relatively secure? All of these factors have to be taken into account.

Two Rules of Thumb:

RoT 1: If you're only paying the interest, or minimum repayments, you're in trouble. The total debt should be reducing over timeor fluctuating such that it doesn't exceed a comfortable level'. Maintaining a steady debt-level is not a problem, if you can continue to service it and keep getting "paybacks". If the assets increase and the debt is constant. That's not a problem.

RoT 2: what would you do if, on pain of death, you had to pay off your debts, in the next six months? For the purpose of the exercise, discount any loan secured against your home (see below).

I'd cancel the holiday, lose a few pounds as I hit the economy-drive diet (all fresh-veg, no- frills home-cooking), walk everywhere, coupon-cut and claim the incidentals on expenses I normally let go. Magazines subscriptions would be cancelledand some of my charitable giving temporarily suspended.

If I then lost my job during those six months? I'd get another one. I'd sell stuff. I'm still confident I could clear.

That's a comfortable level of debt.

If you can't produce an emergency strategy of this sort reduce your borrowing.

"The Mortgage": -

Anything more than 3x your annual income is going to be difficult. Don't be fooled by the lenders into thinking that because they're willing to advance, you are "a good risk". They don't care. If you default, they sell your home, and if that doesn't make good the debt they claim the shortfall on insurance. They can't lose. You can.

Conversely, don't panic about negativity equity. The fact that prices have dropped and your home isn't worth the loan secured on it, isn't automatically a problem. So long as you can keep meeting your payments and don't need to sell, it's irrelevant. Prices will rise again and in the meantime you still have the roof.

Debt has its risks, but it can open up business or life avenues that would otherwise be closed. Don't be frightened of it. Just make sure your exit strategy is up to date.

Learn more about this author, Lesley Mason.
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