Do You Carry Too Much Debt?

The definition of the debt load is the sum total of all amounts you owe. In order to determine how big your debt burden is, you need to calculate your debt/income ratio by dividing what you owe by your total earnings.

These are the main steps to follow:

1. Calculate the sum total of your monthly debt payments. If you don’t have such payments, you should estimate them as being 4 percent of your total debt load.

2. Divide your gross annual salary by 12, in order to calculate your monthly income.

3. Divide the monthly payments total by your monthly income.

4. Divide this amount by 100 to turn it into a percentage – the result is your debt/income ratio.

If your debt/income ratio is 10 percent or less, you can be happy, as your financial situation is excellent. A ratio between 10 and 20 percent represents good credit. If your ratio comes our 20 percent or above, you should take a closer look at the way you manage your money. No bank or creditor will happily give a loan to an individual with such a high debt load. Even those who do make sure they charge a much higher interest rate.

There’s also another way to assess your financial health – you can do it by calculating your net worth, which is directly linked to the total value of everything you own. This is the formula you should use to calculate your net worth:

Assets Vs Liabilities

Assets represent the value of everything you own. You should include here your house, your car, your household appliances, your jewelry items, as well as everything else that can be assigned a value in money.

Liabilities represent everything that you owe. Here you should add your mortgage, any other loans you may have, your credits card balance, and the interest you’ll have to pay for all these loans. If you’ve borrowed money from family and friends, you should add it here as well.

How To Prioritize Loans

Although there isn’t a universal approach to this problem, there are two ways to manage your debt. You should assess your specific financial situation and all implications of each method, and make the choice that suits you best. Once you choose your way, stick to it until you become debt-free.

Debt Snowball Method 

This approach uses the prioritization of debt by size. Start by paying off the smallest loans, and then work your way to paying off the bigger ones. Like this, you’ll manage to get rid of several loans early on, and your payments will “snowball” as you’ll get your psychological rewards. This is the kind of visible progress that motivates people who choose this method.

Debt Avalanche Method

This method involves making the minimum payment on each debt, then use the remainder of your money to pay off the debt with the highest interest rate. Once you’re done with the highest interest debt, you should move onto the one with the next highest interest rate. This method has the advantage of reducing your overall interest rate.