How Much Debt Is Too Much

This is a good question many of us have asked ourselves at one time or another. Of course, the answer will vary by individual based on many factors such as household income, your stage in life (e.g. student, working in career, retired), marital status, number of dependents, geographic area in which you live etc.

One method of assessing the extent of your debt, is to calculate your total debt servicing (TDS) ratio. This ratio shows the proportion of gross (i.e. before tax) income that is already spent on monthly servicing of debts such as credit cards, lines of credit, vehicle loans and housing costs. As a rule, the monthly payments required to service your total debt load should not exceed 40% of your gross income. Having a ratio less than 40% typically means that you have an acceptable level of debt. Conversely, lenders are unlikely to grant or extend further credit if your monthly payments exceed the 40% threshold and those that do are typically higher-risk lenders who apply exorbitant interest and service charges.

One other such measurement is the gross debt servicing (GDS) ratio. Banks are unlikely to grant you a mortgage if your housing costs (i.e. mortgage payments, utilities, property taxes, etc.) exceed 32% of your gross income. This threshold certainly makes it more difficult to obtain a mortgage in some Canadian markets where increases in housing prices have significantly outpaced proportionate increases in household income.

In more general terms, there are many warning signs of financial difficulty that can help you avoid getting caught in a dangerous cycle of debt if you are able to recognize them and get yourself back on track financially. Some of these warning signs are as follows:

• Making payments on one debt using another form of credit.
• Only making minimum payments on credit cards for more than two or three consecutive months.
• Paying for groceries and other essential items on credit without a plan to pay the charges at month end.
• Having to borrow money from friends or family to keep up with day-to-day expenses and debt payments.
• Having to use pay day loan services and / or accessing credit from high interest lenders.
• Receiving collection calls or letters such that you’re afraid to answer the phone or open your mail.
• Lacking awareness of monthly expenses and finances in general (e.g. how much money do you have on deposit in the bank?)

Recognizing that you may be in, or entering, a period of financial difficulty is certainly a positive first step in resolving your debt problems as it demonstrates self-awareness that some financial rehabilitation may be required. Seeking assistance from a Licensed Insolvency Trustee sooner rather than later, may be difference between making some core budgetary changes now versus having to take more drastic measures in the future.