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How much debt is too much? Here are the warning signs

As featured in the Finances FYI section of the the Seattle Times

By 1st Security Bank

For most of us, “debt” is a four-letter word as dirty as any other. We feel bad when we’re in it and glad when we’re out of it.

Actually, it’s a little more complicated than that.

Debt has its uses. Few of us have the resources to buy a home outright without taking on at least some debt. Debt can help us go to college, start a business, buy a car and handle emergencies.

The question is: How much debt is too much? There’s no single answer.

If you have a good job, if you’re healthy, if you keep track of your balances, and if interest rates are reasonable and fixed, debt can be managed. If you’re using debt sparingly and mostly for things that grow in value, like a house or an education, it can be useful.

Fixed-rate home mortgages are near historic low interest rates — and the interest is tax-deductible if you itemize deductions — ditto for many student loans. Some carmakers in recent years have been offering 0% financing.

But there’s also “danger debt”: Debt balances that are too overwhelming, interest rates that are too high, and debt purchases that are for trivial things.

If you’re not careful, danger debt can swallow your life.

The best way to deal with danger debt is not to have it in the first place. Before you add to your debt, figure out if you can handle the added monthly cost with your existing income while paying for your usual expenses and still setting aside some money.

A rule that lenders and others widely use is that your total monthly debt obligation should not exceed 36% of your gross monthly income.

Here are signs that you have danger debt.

Your credit card balances keep getting higher.

If you can’t pay off your card balances each month, you should at least be paying them down steadily. If you’re skipping payments, that’s a big problem.

You’re not saving for retirement.

If you have a 401(k) plan at work and your employer offers matching payments, you’re giving away free money if you don’t contribute. Likewise, if you don’t have a retirement plan at work and you’re not investing in an IRA, you could be missing out on a tax break.

You use low interest rates as an excuse to buy too big.

Just because you can get cheap or free financing on a new car, for example, doesn’t mean you should snatch up the most expensive ride on the lot or get it tricked out with expensive options. You still have to pay that money back. And if you get a long-term auto loan (more than four years), your loan balance may wind up higher than what you could make from selling your car. Put as much money down as you can when you buy and limit the loan term to four years or less.

How much debt is too much? Here are the warning signs

You get eaten alive by your house.

Here again, don’t buy more home than you can afford just because credit is cheap. Even with a cheap fixed-rate mortgage, many experts advise you should keep your mortgage costs to 28% or less of your gross income. If you’re buying a house in your 40s or 50s, consider a 15-year loan so you have it paid off by the time you retire.

You get stung by credit card terms.

Read the fine print before you apply for a credit card. You may get an offer for a zero-percentage-rate card, but after 15 or 18 months, that rate could shoot sky high. Most cards offered today have variable-rate interest that could reach 24% a year or more.

You regularly tap your savings to pay off your debt.

You need at least some money in the bank in case you suffer a setback.

You draw cash advances off your credit cards.

Don’t add new debt to pay off old debt. Besides, credit card companies often charge a higher interest rate for cash advances than for purchases, plus a fee.

You’re applying for payday loans to make ends meet.

Many states don’t set limits on payday loan interest, which can soar as high as several hundred percent.

You’re hitting up friends and relatives to help you pay bills.

You could end up damaging your most important relationships.

If your debt woes are overwhelming, help is available. The Federal Trade Commission offers advice here on coping with danger debt, including ways to find a reputable debt-relief service without getting ripped off.