They’re ba-ack. Like the ghosts in Poltergeist, shoppers have returned this holiday season and they are threatening to stir up a familiar demon—debts they can’t repay.
Black Friday sales set records. Cyber Monday sales were torrid too. Personal spending accounted for the vast majority of third-quarter growth, and spending has been up three of the past four months, reports the Wall Street Journal. The savings rate has fallen to 3.5% from 5.3%.
This is a marked turnaround from the austerity that has gripped the economy since 2008, and while this burst of consumerism seems likely to persist through year-end, it also seems likely to saddle many with a debt hangover. Things just aren’t that good out there. Household net worth is declining; unemployment is high, and German-led fiscal restraint throughout Europe all but guarantees continued headwinds.
I get it: We’re tired of being so darned frugal. Letting go a bit may make some sense. But before you go any further, now would be a good time for a debt checkup. How much debt is too much? Here are some guidelines:
- Mortgage Not so long ago, lenders thought nothing of stretching your budget to obscene levels in order to put you in a house. They might have allowed you to commit as much as 36% of your income to a mortgage and as much as 50% of income to total debt service. More traditional limits are in force today—and should be adhered to even in the unlikely event your banker suffers a flashback. That means a mortgage payment that does not exceed 28% of take-home pay and total debt payments that do not exceed 36%. One in three mortgage holders today is above the recommended threshold, reports consulting firm Strategic Business Insights. Try this calculator to see how you are doing.
- HELOC Closely related to your first mortgage is your home equity line of credit or possibly a home equity loan. Recognize this debt for what it is—an extension of your first mortgage. How much you can safely and smartly borrow with a HELOC or second mortgage depends on how much home equity you have. Your total mortgage-related debt should add up to less than 80% of your home’s value. You’ll get the best interest rate that way, and you’ll be able to tap cash in an emergency. See where you stand with this calculator.
- Student debt You’ve heard all about it: Student loans now outstrip credit card borrowing and total nearly $1 trillion. The typical grad leaves campus owing $25,000. But some owe five to 10 times that figure. Indeed, SBI reports that 2.3 million have outstanding student debts of $50,000 or more—and that includes some 21,000 who have carried this debt into retirement. A good rule of thumb is to leave campus with no more total debt than your first year’s pay, or to keep your monthly student-debt costs to less than 10% of income.
- Credit cards Any balance that you carry from month to month constitutes excessive debt. Credit cards should be valued for their convenience and cash-back rewards as well as for the ready access to cash they afford in an emergency. If you must carry a balance, keep it under 30% of available credit on any given card to avoid a ding to your credit score.
- Auto loans Many people overspend on a car, which they mentally place in the category of a need when it is really a want. Of course you need wheels. But you do not need a new BMW. According to Edmunds.com, the average consumer pays 11% of monthly income to own a car, which leaves little wiggle room for other borrowing—especially if you intend to buy a house. Think of 8% as a ceiling, less if you have credit card balances and student loans too.