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How much Debt can you afford?

Too much debt can cause serious problems. The term ―over-indebtedness refers to household debt that is too high relative to household income.

How do you figure out how much debt is too much? Unfortunately, there is no rule of thumb about a safe debt-to-income ratio, although 20% to 30% of household income is widely used.

Should your household always avoid carrying more than one loan at a time? Not necessarily, especially if you face a crisis and need cash urgently.

Before taking on a loan, you should consider both the costs and risks of borrowing. Answer the following questions based on your own circumstances:

1. What percentage of my household and/or business budget can I afford to make available for debt repayment? Will I have enough left over to adequately cover other household expenses?

2. Can my guarantors afford to repay my loan? How will they feel towards me if they have to do so?

3. What are the consequences if I cannot repay my loan? What is the value of the collateral (for example, a motorbike, house, etc.) I have pledged?

Controlling Debt

Tip!

These days, urban youth around the world finds itself grappling with credit card debt. This easy to understand info-graph by Visual.ly offers some sound advice on how to better manage your credit cards: Reaching Credit Card Nirvana

As a borrower, the debt trap can sneak up on you. Because it occurs slowly, you may not see it coming. Suddenly you owe more than you can afford to pay and the way out is nowhere in sight!

The persistence of debt is one factor that keeps poor people in poverty. For most of us, living with debt has always been and continues to be a reality.

Because your need for credit typically does not go away, you are likely to renew existing loans. In fact, given ever-changing circumstances, at some point you may need more than one loan at a time. This can happen when you are faced with an unexpected crisis and need cash urgently.

Whether managing existing debt, or deciding if you can afford to take a second loan, make sure your debt obligations will not control your life—that you will still be able to pay for your basic needs and daily expenses.

Two simple rules will help you control your debt:

1. Don’t borrow more than you can afford to repay.

Warning Signs of Out of Control Debt!

  • Using credit to purchase things you once bought with cash
  • Getting loans or extensions to pay your debts
  • Using savings to repay loans
  • Using credit for living expenses
2. Save money regularly for emergencies so you do not always have to borrow.

Remember!

  • The total of your loan payments should not exceed a percentage of your steady income
  • Try to limit your borrowing for personal consumption
  • Have a plan for making loan payments if it will take time for the loan to generate increased income
  • Don’t let debt prevent you from paying for basic expenses such as food, school fees and other necessary items
  • Keep track of the amount and frequency of loan payments due

The Bottom Line

Debt is not the enemy. Bad credit habits are.

Use credit well and use it wisely.