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February 27, 2018 | By: Jean Riddell

How Much Debt is Too Much Debt?

Debt Management

Canada’s wealthiest family, the Thompson Family, were reportedly worth a whopping $40 billion as of last year. But whether you make $40 billion or $4,000 a year, we all have a certain threshold or limit to how much debt we can safely manage. The good news is there are some simple formulas that can tell you how much debt you can be expected to reasonably handle—and when it’s time to get a better grip on your finances.

How Does Your Debt Compare to the National Average? 

When calculating your finances, it’s important to focus only on your individual situation, rather than getting caught up in how your BFF or neighbour are doing. Still, people like to see how they stack up when compared to their peers; it’s human nature.

To quench this insatiable curiosity and help you move forward so you can focus on you, here it goes: The average debt for Canadians reached just over $22,000 in 2016. Gen Xers reported having the most debt, which makes sense since most have kids, parents to care for, plus a mortgage. Boomers reported having far less debt, with their kids now grown and their homes paid off (for the most part). Finally, there's the Millennials, many of whom don’t yet have kids and are more likely to be renting, so they reported considerably less debt than both.

Age & Average Debt:

  • 18-25: $8,500
  • 26-35: $17,000
  • 36-45: $33,000
  • 56-65: $27,000
  • 65+: $15,000

Types of Debt: The Good, The Bad, and the Ugly

Wait a minute, how can debt be considered good? It’s considered good in the eyes of lenders when the interest rate is fixed or low, and the debt is attached to something that's expected to grow in value, like a home or condo.

Bad debt, on the other hand, are loans with high interest rates, and used to buy things that lose value or depreciate over time, like a car. Credit cards are a prime example of bad debt, along with personal loans and auto loans lasting five or more years.

And then there's ugly debt — debts of the toxic variety, like payday loans. These loans carry insane APRs, some known to go nearly as high as 400 percent! 

In order to get a better understanding of your financial situation, it helps to know which categories your debts fall into, and exactly how much debt falls into each category.

Credit Scores: Know Your Numbers

While a credit score doesn’t paint your full financial picture, it can provide a quick snapshot of your overall financial health, which can help you see how a potential lender might view (and evaluate) you. Most importantly, it can shine a light on some credit blemishes that, in time, you can start to repair.

When credit reporting agencies calculate your credit score, they typically look at five main factors, which are listed below: 

  • Payment history. Your payment history is probably the most important factor when it comes to calculating your credit score. Bottom line: Pay your debts on time every single month to avoid a low score, even if you're just making minimum payments.

  • Credit utilization. The amount of credit you have available versus the amount you’re using. The magic number hovers at around 30 percent; anything more typically sends a red flag. So, if you’ve got $5,000 in available credit, you shouldn’t be using more than $1,500.

  • Credit history. The longer you’ve had accounts open for (and in good standing), the better.|

  • Diversity. A variety of different credit and debt accounts in good standing, such as credit cards, lines of credit and a mortgage, shows that you can manage credit like a pro. 

  • Inquiries. The number of times you've attempted to secure more credit through other creditors. If your file shows that you've had multiple creditor inquiries within a relatively short amount of time, it could be an indicator that you're experiencing financial issues. 

Pro tip: When it comes to credit utilization, rather than looking at an overall credit utilization of 30 percent, some agencies instead want to see that you’re using under 30 percent on each card. So, if you have one credit card that’s maxed out but another that’s empty, you might want to consider transferring some of that debt over to the card without a balance. But only consider doing this if you have the same APR for both cards.

Debt-to-Income Ratios: Hitting the Sweet Spot 

Your debt-to-income ratio or DTI is the amount you owe versus the amount you earn. The good news is that it’s fairly simple to calculate. It involves adding up all your monthly fixed expenses and dividing that total by your net income. Variable expenses, such as utilities, gas, and groceries, are generally not factored in simply because of their fluidity. (You can always turn down the heat, ride your bike, or purchase fewer groceries.)

Fixed expenses include:

  • Monthly mortgage or rent
  • Home insurance or association fees
  • Car payments
  • Minimum payments on credit cards
  • Minimum payments on student loans
  • Minimum payments on lines of credit

Lenders use this percentage, in conjunction with your credit score, to determine your financial health. Most Canadian banks agree that a DTI between 35-40 percent is the sweet spot, with anything less showing especially remarkable restraint. (Congratulations!)

For those of you still playing the comparison game, Canada’s overall DTI ratio is at an all-time high of 171 percent. But again, don’t let other people's score get in the way of yours. Just because your ratio might be less than the average, it doesn't mean you shouldn't keep yourself within that sweet spot, or as close to it as possible.

Taking the Next Steps

By understanding the differences between different types of debts, and understanding your credit score and DTI ratio, you’ll be in a better position to begin budgeting like a pro and eliminating debt. Of course, Credit Canada understands that sometimes everyone needs a little help. If you feel overwhelmed by a burden of debt, our expert credit counsellors are always available, for free. Contact us today at 1-800-267-2272 or reach us online, anytime.

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