Debt is a powerful tool that can help or hurt your finances depending on how you use it. Savvy consumers know how to leverage low-interest debt to purchase assets that are likely to increase in value over time, such as a home or business. Education debt can also pay off over time if it allows you to earn more.
But many people abuse debt and allow their finances to get out-of-control. In this post, I’ll cover 13 warning signs that you may have a debt problem. You’ll learn red flags to watch out for that could prevent you from building wealth and solutions to turn around your financial life.
1. You don’t know what you owe.
If you don’t know how many debts you have or their approximate balances, you need a reality check! If you’re avoiding opening your bills or looking at credit card statements because you don’t want to see the balances, then you already know you have a debt problem, and it’s time to do something about it.
Take the time to create a spreadsheet listing each account name, number, interest rate, and the amount owed. In general, it’s best to tackle debts with the highest interest rates first, such as payday loans and credit cards, since that gives you the most potential savings.
Hiding from a financial problem doesn’t make it go away. Knowing where you stand with debt is the first step to getting it under control and improving your entire financial life.
2. Your debt-to-income ratio is too high.
Your debt-to-income (DTI) ratio is a key formula expressed as a percentage that lenders use to evaluate you, and you can use it, too. To figure it out, add up your total monthly debt payments – including credit cards, loans, and your rent or mortgage payment – and divide that amount by your gross (pre-tax) monthly income.
For example, if you earn $5,000 and your debt totals $2,500 per month, your DTI is 50% ($2,500 / $5,000 = 0.5). Most lenders consider a DTI above 40% too high, especially when you’re applying for a mortgage. So a 50% DTI means that you have more debt than you can handle for your income.
But even if you don’t plan to buy a home or get a large loan anytime soon, calculating your DTI is a good way to monitor your financial health. Watch it over time to make sure that it decreases and never goes up.
The solution to a high DTI is to pay off debt by cutting expenses, increasing your income, or doing both. Additionally, paying down your outstanding debt balances boosts your credit. That may allow you to qualify for debt optimization tools, such as a balance transfer credit card or a low-interest personal loan.
3. Your interest-to-income ratio is too high.
Another revealing ratio compares the total of your monthly interest charges on all your debts to your gross income. If it’s more than 20% of your monthly income, take quick action to reduce it.
Paying high inters rates on debt means that you may not have enough left over each month to cover your basic living expenses, such as housing, food, and transportation. Try shifting balances to a low-rate personal loan or taking advantage of a 0% interest balance transfer credit card to get some financial breathing room.
4. You can only make minimum payments on cards.
If you’re stuck in a cycle of only paying the minimum on credit cards each month, that indicates you have a debt problem. As interest accrues, you could end up paying double or triple the original cost of the items charged on the card.
For example, let’s say you have a $5,000 card balance with an 18% annual percentage rate (APR) and a $100 minimum payment. If you only pay the minimum, it will take you over 30 years to eliminate the balance!
But if you pay $250 per month, you’d pay off the balance in under nine years. And paying $500 would allow you to eliminate the debt in just over four years.
These pay-off time frames assume that you don’t increase credit card balances with any additional charges. So, make a plan to stop making new charges and to pay as much as possible on credit cards each month to get out of debt as quickly as possible.
5. Your credit cards are maxed out.
If you’re using credit cards to satisfy a shopping habit or to buy necessities during a financial rough patch, you’ll eventually hit your credit limit. You may be charged additional over-limit fees if purchases exceed your credit limit.
Even if you can pay more than the minimum payment each month, having a maxed out card causes your credit utilization ratio to skyrocket, which kills your credit scores. If you’re consistently using more than 20% to 30% of your credit lines, you probably have a debt problem that needs to be reined in.
If you’re living beyond your means and financing a lifestyle that you can’t afford, it’s time to create a realistic spending plan and take control of your finances.
6. You can’t pay bills on time.
If you’re not paying bills on time, it could be because you’re extremely unorganized. But it’s more likely that your debt payments are more than you can afford to pay each month.
Ignoring bills may make you feel better in the short term, but I promise that they’ll come back to bite you in the form of late fees and bad credit. Paying late only makes a debt problem worse.
Contact your creditors to discuss any financial hardship and ask for their help. You may be able to work out a payment plan to get caught up with past-due balances or have late fees waived.
7. You’ve borrowed to pay your bills.
If you have to borrow money from friends or family or take cash advances on credit cards, you certainly have a debt problem. Getting cash from a credit card is the worst way to use it because you’re charged a higher interest rate than for regular purchases. Additionally, you usually get hit with a cash advance fee.
Eventually, you’ll run out of places to borrow and you’ll have to face the balances you’ve racked up. So, make a plan now to reduce your expenses and increase your income sources so you live within your means without having to borrow from loved ones or expensive creditors.
8. You overdraw your bank account.
I don’t know too many people who have never accidentally bounced a check – even me. However, if you’re paying expensive non-sufficient funds (NSF) fees on a regular basis, it’s probably because you’re spending more than you make and have a debt problem.
The cure is to create a budget so you know what your expenses are and how much you earn. Aggressively cut back on all unnecessary expenses and brainstorm ways to increase your income at the same time.
9. You don’t have savings.
Even people who aren’t in debt can make the mistake of not saving. But if you’ve drained a savings or retirement account to pay off debt or to pay for everyday living expenses, that’s when you know you have a debt problem.
If you don’t have savings, you’re living on the edge, financially speaking! Any unexpected expense could send you into a tailspin that causes you to go further into debt. Make a plan to radically cut your expenses and begin setting aside as much as possible each month in an FDIC-insured savings account.
Having cash on hand is the best way to avoid having to use debt in the first place. It’s how you’ll keep your head above water if you have a large unexpected expense or loss of income.
Make a habit of saving (even small amounts) to your emergency fund. Start by setting aside 1% of your income until you have several months’ worth of living expenses as a cash cushion. Then make a goal to save a minimum of 10% to 15% of your gross income in a retirement plan at work, an IRA, or a retirement account for the self-employed.
10. You’ve been turned down for new credit.
If you’ve recently been denied credit or can only qualify at a high rate, you may have poor credit, too much debt, or both. Review your credit using a free site such as Credit Karma or AnnualCreditReport.com to make sure there isn’t any incorrect information on your credit reports.
To learn more about how credit scores are calculated and how to raise your credit, read or listen to the podcast version of 7 Essential Rules to Build Credit Fast.
11. Your finances cause you to lose sleep.
If you’re so worried about your debt and bills that you can’t sleep at night, you certainly have a problem. Financial stress can lead to trouble focusing on your work or poor health.
Losing your job or business income is the last thing you need when you already have money problems. So, make a plan to deal with your debt and get your stress under control as quickly as possible.
12. You lie about your finances.
If you’re lying to family or friends about your spending habits or how much debt you have, it’s because you know deep down that there’s a serious problem. If you’re worried, losing sleep, and having trouble concentrating due to debt, it’s time to take action.
Create and stick to a realistic budget, make an appointment with a financial planner, or see a debt counselor. The National Foundation for Credit Counseling at NFCC.org is a great resource.
The only way to improve a bad situation is to be brave and face it head-on. Denying a debt problem only makes it worse and prolongs your agony! The sooner you address it, the sooner you’ll make positive financial changes.
13. You’re getting calls from debt collectors.
When debt collectors start calling you, your debts are seriously delinquent and you have a big-time debt problem. If you don’t face past due debt head-on, you could end up in a lawsuit, have your wages garnished, have your home foreclosed, or have a vehicle repossessed.
Be cautious about communicating with a collector on the phone. Even a short conversation is risky because you could accidentally say something that gives them a leg up or resets the statute of limitations on an old debt.
Never admit that you owe a debt or engage in conversation or debate about the issue. Just ask for the company name and address and say you will only communicate through the mail, and then hang up. Always get professional help from an attorney who can help you understand the collections laws in your state and help you navigate wise options.
To sum up, the problem with debt is that it puts unnecessary strain on your finances that keeps you from making positive progress, such as building an emergency fund, investing for the future, and reaching your financial goals.
Never go into debt for anything that doesn’t give you a return – like consumer goods, dining out, or fancy vacations. Financing those types of purchases, especially on a high-interest credit card, causes you to lose wealth instead of to build it.
So, if you’re wondering if you have a debt problem, you probably do. Lenders are usually willing to dole out more debt than you should have. Setting limits is your responsibility.
The good news is that if you recognize these warning signs, it’s never too late to turn around your finances, pull yourself out of a debt hole, and make better choices.