Dear Liz: I’m paying down credit card debts. At what ratio of debt to income would you consider my personal finances healthy?
Answer: The healthiest level of credit card debt is none. Credit card interest rates tend to be high and variable, which makes this kind of debt toxic to your financial health. Congratulations for making progress on getting rid of yours.
There are a number of measures you can use to judge whether an appropriate amount of your monthly income goes to debt payments. Among the most common:
- Traditionally, mortgage lenders preferred home loan payments to be 28% or less of your gross monthly income and total debt payments, including mortgage, to be 36% or less.
- Debt payments, including mortgages, that exceed 40% of gross monthly can be an indication of financial distress, according to the Federal Reserve.
- Under the 50/30/20 budget, all your must-have expenses — including housing, utilities, transportation, insurance and minimum loan payments — would be 50% or less of your after-tax income (your gross income minus income and payroll taxes). That leaves 30% for wants and 20% for savings and extra payments on debt. If a loan payment fits under the 50% limit with all your other must-haves, then it may be considered affordable.
You typically don’t need to rush to pay off lower-rate, potentially tax-deductible debt such as mortgages or student loans. Still, you’ll probably want to have all your debts paid off by retirement so you aren’t draining your nest egg to make the payments.
Speaking of retirement, are you saving enough for that goal? Do you have a sufficient emergency fund? Are you adequately insured? Are you able to enjoy your life without excessive stress about money? Financial health includes all those components in addition to paying down debt.
Liz Weston, certified financial planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at AskLizWeston.com.