Debt can be good or bad, so this quote from Nathan Morris really only pertains to bad debt. I wanted to share this because I think it puts debt into perspective.
When you borrow money you are making yourself contractually obligated to pay it back with interest. These interest payments, if small relative to your cash flow, will likely not impact your overall financial position. However, if the interest payments are large and are unable to be paid, or if they take up too much of your cash flow, they can have serious negative consequences.
How Much Debt Can You Afford?
So the next logical question is, how large a debt payment is too large? Everyone’s situation is different, but I would suggest that you have to back into the answer after accounting for all of the necessities first.
If you make $48,000 after-tax, you have $4,000 per month to spend/save. From these funds the following need to be allocated:
- The purchase of all necessary insurance
- Funding an emergency account
- Funding a retirement account
After these are accounted for, what you have remaining is what you have to spend on food, entertainment, living expenses, and other financial goals. What you are likely to find is that there isn’t a lot left remaining to go toward debt payments.
Debt and Our Future Goals
Unfortunately, most people are told they can have debt-to-income ratios of 40% or higher, that is 40% of their “gross” income. This can leave as little as 15% after taxes and debt payments to cover the essentials I listed above. This is an impossible situation for anyone trying to save for retirement and other financial goals, like their child’s education.
With that much debt we are robbing our future selves. With debt ratios that high we are never able to earn interest. Instead we are always the ones stuck paying it.
If you haven’t recently reviewed your financial plan you should contact your CERTIFIED FINANCIAL PLANNER™ Practitioner.