If the mere thought of opening your credit card bill at the end of each month makes you sweat bullets and go a little weak in the knees, you're probably not alone. According to the Federal Reserve Bank of New York, Americans owed a jaw-dropping $856 billion in credit card debt as of Q4 2021. The average cardholder owed $6,569. But how much credit card debt is too much?
What constitutes too much credit card debt differs from one person to another. However, there are three simple calculations you can do to determine when your debt may be too high. This includes calculating your credit utilization ratio, debt-to-income ratio, and credit card debt ratio.
Keep reading to find out what each of these calculations means, how much credit card debt is acceptable, and how credit card debt affects a large loan like a mortgage. Buckle up because you may be in for a shock if you haven't been managing your finances responsibly.
What Is Considered High Credit Card Debt?
These days, it's super easy and convenient to whip out the plastic for purchases. Groceries? Charge it. Dinner at a restaurant? Charge it. New pair of shoes? Charge it.
Since a credit card is revolving debt, the minimum payment increases as you charge more to your card. Before you know it, payments can consume your budget and steal any free cash flow.
When you factor in interest, it's not hard to see why credit card debt has a tendency to creep up on people, causing financial chaos. If the situation is severe enough, you may not be able to cover daily expenses. The worst part is that it's not always immediately apparent your credit card debt is becoming too much to handle.
How Can You Tell When You're Carrying Too Much Credit Card Debt?
Fortunately, there are three simple ratio calculations you can use to assess whether you're overextended and need to focus on paying down your credit cards.
1. Credit Utilization Ratio
Your credit utilization ratio (also called "amounts owed") refers to how much of your total available credit you're using. It's the second biggest factor that contributes to your FICO credit score, accounting for 30% of your score's weight.
The reason your credit utilization is so important is that it essentially offers insight into your ability to manage debt. Although having balances on your credit accounts doesn't make you a high-risk borrower, high balances can mean you're at greater risk of paying late or defaulting entirely.
As a rule of thumb, your utilization ratio should stay under 30%.
For example, let's say that you have one credit card with a $10,000 limit. Keeping the 30% utilization ratio in mind, you should try not to charge more than $3,000 to that card.
Now let's say that you have one credit card with a $5,000 limit, another card with an $8,000 limit, and a third card with a $12,000 limit, effectively totaling $25,000 in available credit. At 30% utilization, you shouldn't charge more than $7,500 across all three cards.
Of course, credit utilization takes into account available credit across all types of credit accounts, including installment loans. However, since you're trying to keep credit card debt under control, you can apply the ratio specifically to your credit card balances to ensure you're not charging too much to your plastic.
2. Debt-to-Income Ratio
Your debt-to-income (DTI) ratio refers to your total monthly debt payments divided by your gross monthly income (i.e., what you earn before deductions, such as taxes). Lenders use this calculation to determine whether you can repay the money you want to borrow, as they don't want you to borrow more than you can afford.
A good DTI ratio is below 36%, while anything above 43% may disqualify you from securing further credit.
How does the calculation work?
Let's say your total debt obligation each month is $1,500. That includes a mortgage payment, a car loan payment, and credit cards. If your gross monthly income is $5,000, your DTI ratio is 30% ($1,500 of $5,000 is 30%). In this case, you're still in the safe zone.
A DTI ratio that is 36% to 42% will cause lenders concern, so you may struggle to borrow money. A DTI above 43% is likely to result in the outright rejection of your credit applications.
Even though you're not applying for credit, you can use this calculation to ensure your monthly credit card obligation isn't pushing your total monthly debt obligation so high that your DTI ratio falls into the red zone. For example, if your DTI ratio is 45%, then you know you need to start working on your credit card debt to bring that ratio down.
3. Credit Card Debt Ratio
Another simple way of evaluating whether your credit card debt is too high is to calculate your credit card debt ratio. You do this by taking your total monthly credit card payments owed and dividing the amount by your monthly net income (i.e., your take-home pay after taxes and other deductions). Experts recommend that this shouldn't exceed 10%.
For example, imagine you have the following minimum payments to make across three credit cards:
- $100 on Card A
- $80 on Card B
- $60 on Card C
That brings your monthly credit card obligation to $240. Now imagine your monthly net income is $3,000. In this scenario, your credit card debt ratio is 8%, which is still viewed as acceptable.
However, as your credit card debt ratio increases, the tougher it's going to be to manage your budget. To avoid juggling bills, relying on overdrafts, and delaying critical expenses like doctor visits, home repairs, and car maintenance, make sure that your minimum credit card payments due each month total no more than 10% of your net income.
With these three ratios in mind, you may be wondering if there's an allowable or justifiable level of credit card debt.
Further Reading: Credit Card Debt Forgiveness- YOUR COMPLETE GUIDE
How Much Credit Card Debt Is Acceptable?
The answer depends on who you're asking. For some people, $1 is too much, while others are happy to max out their credit cards without a second thought about how it may affect their credit scores or creditworthiness.
When it comes to financial institutions and other credit lenders, the calculations detailed above are some of the best guidelines you're going to get for what's considered acceptable. Ideally, you'll pay off your credit card balances each month to keep your ratios as low as possible.
Perhaps a better question is: how much credit card debt is considered unacceptable?
Here are just some of the key signs you may be in over your head:
- You're using one credit card to make a payment on another. Although you can't do this directly, you can use cash advances and balance transfers, which will likely cost you more.
- You're only making minimum payments, which means you're barely putting a dent in the principal amounts owed. In other words, a fair chunk of your payment is serving the interest rather than the amount you borrowed.
- You don't have enough cash to cover even the minimum payment. This can indicate you're spending well beyond your means.
- Your credit cards are maxed out. Your credit card debt is probably out of control if you're consistently hitting your spending limits.
- Your credit card payments are significantly higher than your other bills. If the total of your card payments nears typically bigger monthly expenses like a mortgage or car loan payment, the chances are you have too much credit card debt.
What if you want to take out a large loan like a mortgage? How will high credit card debt affect your approval chances?
How Much Credit Card Debt Is Too Much For A Mortgage?
Whether you're a prospective house hunter or you want to refinance your existing mortgage, your credit card debt will factor into mortgage affordability calculations—either directly or indirectly.
For example, a lender will assess your credit score, which is impacted by your credit utilization ratio. More directly, they'll evaluate your DTI ratio to better understand what you can afford in mortgage debt each month and at what interest rate.
If you want to ensure you qualify for a mortgage loan, start by making sure your credit report is untarnished and that you have a DTI ratio well below 36%. What that looks like in actual dollar amounts depends on your debt and income figures.
A Final Word of Advice
Unfortunately, if you're asking how much credit card debt is too much, then chances are you're concerned about yours. The reality is that high credit card debt has a multitude of consequences you want to avoid at all costs, including tanking your credit score, increasing your debt quickly, and precluding you from certain financial products. In addition, your creditors can put you into collections and have your wages garnished for missed payments.
To ensure you don't wreck your financial future with negative tradelines on your credit report, use the ratios described in this post to assess whether your credit card debt is too high. If your figures start to set off internal alarm bells, create a budget and payment plan to pay down your credit cards ASAP.
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Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.