1 in 3 Americans Don't Know How Much of Their Income Goes to Debt
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Debt is a four-letter word in many households. Some people don’t want to talk about it or face the debt they owe. Whether it’s because they’re ashamed of their debt or they don’t know how they’re going to pay it back, ignoring debt can become a significant problem.
If you’ve been ignoring your debt, you aren’t alone. But figuring out how much you owe can help you take control of your situation.
Why 1 in 3 Don’t Know About Their Debt
According to a recent study from Northwestern Mutual, more than one in three Americans don’t know how much of their monthly income goes toward paying off debt. To make matters worse, roughly one in five Americans don’t know how much debt they carry.
Debt may cause stress, anxiety, and physical illness.
When we’re faced with something we’re uncomfortable with, the first reaction to stress or fear is avoidance, according to Dr. Alex Melkumian, founder of the Financial Psychology Center in Los Angeles, California.
The Northwestern Mutual study found that 45% of Americans with debt feel anxious, 35% feel guilty, and 20% feel physically ill about their debt at least once a month.
Anxiety can become a self-fulfilling prophecy. If you’re anxious about your debt, you won’t feel motivated to tackle it. But the more you ignore it, the more anxious you may feel. This creates a negative feedback loop that can be hard to stop.
Anxiety can create physical symptoms such as muscle tension, shortness of breath, insomnia, and fatigue, Dr. Melkumian said. People with these symptoms may not be able to confront their debt as easily as others.
Large amounts of debt can cause a feeling of hopelessness.
Others may avoid their debt because the total amount owed is significant, and it will take a long time to pay it off. About 12% of people had no clue how long they’d be in debt, while 15% of people believed they’d be in debt for the rest of their lives.
“People think of their debt as scary by the time it accrues to a certain number,” Dr. Melkumian said.
This number varies by person, but the longer you feel you’ll be in debt ,the more hopeless you may feel about your situation.
People may think they have everything under control.
Some people don’t check how much they owe because it’s not a pressing issue. They may feel like they have a good handle on their financial situation. They make their payments without any issues, but still can’t calculate how much of their income goes toward debt.
“I am one of those Americans who didn’t know how much debt they had,” said Steffa Mantilla, owner of the personal finance blog Money Tamer. “We would purchase everything based on the payments. If the car dealership or furniture store ran our credit and said we could afford it, we’d go forward. Over time, it adds up and you don’t realize that you have thousands of dollars leaving every month via monthly payments.”
To calculate the percentage that your monthly debt payments take up compared to your income, you have to know your combined debt and income numbers. These numbers aren’t readily available for people who aren’t tracking their payments regularly. They have to spend time researching and compiling this information to get the answer.
Why Knowing Your Debt is Helpful
While ignorance may feel like bliss, being oblivious about your debt won’t help improve your finances. Even if your monthly payments are under control, being aware of how much you owe and how much of your income goes toward paying off debt is important. It may motivate you to get out of debt faster.
“Knowing how much debt you have gives you clarity and the power of choice,” Dr. Melkumian said.
Being aware of your debt situation helps you gauge how much money is left to tackle your other financial priorities. This can include saving for retirement, paying for your child’s college education, or traveling abroad. The less you owe, the more you have available for other goals.
If you plan to apply for a mortgage, knowing your debt-to-income ratio is vital. Lenders require your debt-to-income ratio to be below a certain amount to qualify for various loan programs.
While the ideal goal is maintaining a debt-to-income ratio of less than 36%, a few mortgage programs allow ratios as high as 50%. If you know your debt-to-income ratio, you can figure out how large of a mortgage you may be able to get approved for based on your current income and debt levels.
How to Calculate Your Total Debt
You can calculate your total debt in two main ways. First, add up the balance you owe on each of your loans and lines of credit, including credit cards, student loans, car loans, mortgages, personal loans, and and any other outstanding debts.
The other way to calculate your total debt is to add up the monthly payments you make each month. This can help you answer the question of how much of your monthly income goes toward paying off debt. For most types of debt, use the minimum amount due each month.
When using the monthly payment method, calculating your mortgage payment is an exception. You can’t always add your full monthly mortgage payment. Most people have an escrow payment (used to pay homeowners insurance and property taxes) as part of their monthly payment.
To get the debt portion of your mortgage payment, consult your mortgage statement. Then, add the principal, interest, and private mortgage insurance (PMI), if applicable.
Once you know the total debt payments, divide it by your monthly income. This method gives you insight into how much of your income goes toward making your debt payments each month. Once you have this information, you can calculate your debt-to-income ratio.
Where to find your debt
Finding how much you owe can be problematic if you haven’t been tracking it in the past. First, decide what kind of system you want to use to track your debt.
“If you’re a paper and pencil person, then do that,” Dr. Melkumian said. “If you’re very high tech, then you can do your own spreadsheet.”
You can find your debt in a couple of ways. The first is to watch for all debt-related bills you get over the next month. Every time you get a bill emailed or sent to you, put it in a folder. At the end of the month, add up all of the debt.
Your credit reports can help you find your debt faster. You can visit AnnualCreditReport.com to get a copy of your credit report from Equifax, Experian, and TransUnion. The information may not be 100% up to date because it may not reflect your most recent payments, but it should be fairly accurate.
If your creditors don’t report a debt to one of the bureaus, then it won’t show on your credit report. That’s why you should double check this against the bills you receive and the payments you make.
How to calculate your debt-to-income ratio
Calculating your debt-to-income ratio is easy once you pull together the underlying numbers. There are two ratios you can calculate. The ratios use the same numbers for debt, which is your total monthly debt payments. However, they use different numbers for income.
The first debt-to-income ratio uses your gross income. Your gross income is all income you receive before taxes or other payroll deductions. For salaried individuals, this is your salary. For hourly individuals, it’s your hourly rate multiplied by the number of hours you work.
To calculate your debt-to-income ratio based on your gross income, divide your monthly debt payments by your gross income. You can use this debt-to-income calculator to do the math for you. This is the debt-to-income ratio most mortgage lenders use when calculating how much mortgage you can get approved for.
The other debt-to-income ratio uses your net income. While definitions may vary on exactly what to exclude from your gross income to get to your net income, the easiest way is to use your paycheck’s net amount as your net income.
This is the amount of money that’s actually deposited in your bank account on payday. However, many people have their healthcare premiums or 401(k) contributions taken out of their income. If that’s true in your case, you’ll add those back in for the sake of this ratio.
To calculate your debt-to-income ratio based on your net income, divide your monthly debt payments by your net income. This ratio is more useful for figuring out how much of your available income goes toward debt payments each month.
Finding Your Total Debt Can Be a Wake-Up Call
Figuring out exactly how much you owe can be an eye-opening experience. For some, it’s less than they thought. For others, it’s much more.
Regardless of what you find out, knowing your numbers gives you the power to change your situation for the better. Once you know where you stand, you can start getting out of debt. This may include creating a budget, starting a side hustle, or becoming more mindful of how you spend money.
Understanding your debt can motivate you to stick to a budget or cut back on spending. This may be the best wake-up call you can get. You can look to others for inspiration to see it’s possible to get out of consumer debt for good.