How much is too much debt?


Is there a magic number or the right ratio that can help assess if you have too much debt? Should you stop at $100,000 or $800,000? Clearly the answer is not as simple as an amount or a ratio. While all lenders have their own affordability calculator that assesses if you can afford a new loan or if you already have too much debt, as a borrower you need to have your own understanding  of the situation.

Unsecured Debt

When it comes to unsecured debt such as personal loans, credit cards, store cards, cash loans etc, even $1 owing  is too much debt. If you have such loans they are invariably hangovers from some lifestyle expenses you had decided to take on in the past. They may be debts from prior shopping sprees, holiday experiences or your wedding. They may be debts that paid for your home furniture or your new blinds.

Even if you are on  good income and can easily afford the repayments on these debts, the interest costs are really a waste of money. For many people the experiences they have purchased on credit years previously end up costing them double and triple the item cost.

Therefore if you borrow for any purpose other than, housing, investment or business, any loan is a loan that you should not have. If you do, you should aim to pay it back ASAP.

Secured Loans

Secured debts are debts that are secured by assets. Some of the best examples of a secured debt is your home loan, your property investment loan, car loan, bike loan, caravan, loan, boat loan etc.

These loans tend to be a little cheaper than unsecured loans but are also usually much larger in amount.

Lets take a mortgage of $500,000 as an example. The costs of this loan will be largely the same whether you are buying to live in or to rent out as an investment. A borrower may find that a mortgage of $500,000 is affordable if applied to an investment property but not if applied to their home.

The main reason for this is that with an investment property you are expecting to generate some rental income to be available to offset the costs of the mortgage. This is not there is you are looking to borrow for a home to live in. The other reason of course is tax deductibility of interest and other holding costs. Investment loans generally offer tax deductions to the borrower whereas home loans do not.

Secured loans such as car loans, boat loans, etc are lifestyle loans (unless the vehicle is used for business) and do not offer tax deductions nor added revenue. In most circumstances the smaller these loans are the better off is the borrower.

Ultimately you may find that $1 million dollars mortgage borrowed for an investment property that is generating an income of $60,000 as well as offering potential capital appreciation and tax deductions, is more affordable than a home loan of $700,000 in conjunction with a boat loan of $50,000.

In assessing if you have too much debt one must look at what potential wealth creation and income benefits that debt offers. Debt that does not offer such benefits is best kept to a minimum.