How much debt is too much

Newlywed Sahu is a successful, intelligent young man, lovingly addressed as "Sahu Ji" even by the elders of the community. He strongly feels responsible for the improvement of his locality and is consulted on its important matters. But one day, when he told the local kiranawala to enter the bill amount in his “account”, he was asked to clear his old dues first. Sahu felt very angry, but he felt more insulted.

He never kept any dues for long; he paid them the next month if not in the same. Why this insult then?

The kiranawala even knew the reason for the delay of more than two months. It was because of all that expense for his wedding four months ago. Sahu owed his relatives money and will have to take a loan to clear off that debt. Moreover, only last month, he took a home loan and a cash loan of Rs 1,50,000/- too to furnish the new house. His wife liked a Samsung LED TV and a double-door refrigerator as well, which came with another loan worth Rs. 1,50,000. 

 The kiranawala should understand the stress of a newly married person. What was he thinking? That he would run away? The kiranawala was only adding to Sahu’s stress.

This sure smells like a debt trap, but the question is – could he have avoided it?

Arvind: Sahu’s case is not unique. People are always taking loans, either to buy things to have a better lifestyle or to meet a temporary cash shortage. Even paying with a credit card at a restaurant is basically udhari; you are eating on credit now but will pay later.

Nisha: But people take loans knowing fully well they must pay back – erm… someday.

Arvind: A loan itself is not bad. However, the practice becomes a problem when one cannot draw a line or say ‘STOP’ for certain expenses and go on taking loans. They purchase more than they should on credit and thus, their dues keep growing.

This brings us to the question: How much debt or udhari is too much?

Like some indicators tell us whether our blood pressure is high or low, there are ‘3 Debt Pressure Pointers’ that can help you keep your borrowings in check.

Debt Pressure Pointer 1 - What is too much in the eyes of your lender?

When you approach a bank or loan company, the loan manager will check your income as well as existing debts and repayment history, to calculate your Debt-to-Income (DTI) ratio. DTI helps you determine how much you can comfortably borrow based on your income.

• Udhari is called ‘debt’ or “loan” in English.

Lenders feel comfortable when your DTI is less than 40%. What this means is that when you add up all your monthly loan payments – credit card dues, house loan EMI, car loan EMI etc. – it should not be more than 40% of your income. So, if your monthly salary is Rs 30,000, your total monthly repayment towards these loans should not be more than Rs 12,000.

Sahu: But I keep getting calls for new loans. Can I take another loan to meet my ever-rising expenses?

Arvind: No, Sahu. Taking more loans when you are already struggling with the existing ones won’t be wise.

A software engineer like you working at an international company would earn well. I would advise you to reassess how you are managing your money instead.

Debt Pressure Pointer 2 - When your budget says it’s too much!

Another way to know if you have borrowed too much is to make a monthly budget and see if you can contribute towards these four broad goals:

· Saving towards a secured future- Fulfil aspirations and retire rich.

· Setting aside some amount every month to tackle emergencies - illnesses, car breakdown, sudden travel plans, job loss, etc.

· Paying monthly instalments on other loans comfortably.

· Managing your regular monthly expenses like food, clothing, utilities etc.

This is called the ’budgeting ratio’, which means you break down your take-home pay under different heads.

Please remember, the breakup below is just a suggestion. You can make allotments that are more suited to your personal needs. However, the following is a good starting point:

· 15% saved for long term goals or retirement corpus.

· 15% on short term investments and emergency fund.

· 30% (maximum) on housing. Ideally, this should be for home loan EMI as it means you are building an asset. If you are living in your own home, you can distribute this amount between saving for retirement corpus and investments.

· 10% on other dues (credit card, car/bike loan, etc.) Since the auto loan is fixed, you may have to adjust your credit card use.

· 30% on everything else, including utility bills like power and gas, and entertainment.

If you follow this general discipline, your life will have zero bad debts. If you ever feel that new debts will take your DTI past 40%, then stop right there!

Sahu: It all seems so difficult. But I need to bring about some financial discipline. By the time I’m halfway through a month, I don’t know where most of my money has gone. 

Arvind: It is actually not so tough if you do it at the beginning of the month. Allocate money under different heads, as mentioned above, and make it a habit. After you have put money aside for savings, monthly expenses, and paid all your dues, you can spend the remaining amount on discretionary expenses.

Sahu: I just worry every day about making ends meet. I didn’t know getting married would be so stressful. 

Arvind: You may not have realized, but that is an indicator of stress caused by debt, which is a part of the third pressure pointer.

Debt Pressure Pointer 3 - When the stress caused by debts says it’s too much

Not being able to pay on time brings behavioural changes and monetary challenges, which has a deep impact on one’s health and relationships. Following are some of the most common ones among people in debt.

Sahu, I've never seen you lose your cool before. But lately, you have been getting impatient about every small thing, and you don’t even smile often. If you observe more of these changes in yourself, it’s time to take steps to mend your relationships as much as your bad credit history. 

You can start with these simple steps.

· Cut down spending on things you can do without for the next few months.

· Find ways to supplement your income. If your wife wishes so, she can start working too.

· Set aside a portion of your monthly income as savings for emergencies.

Keep your borrowings in check and whenever you see any of the above indicators, try to bring your DTI ratio down so that your finances don't get thrown off track.

Go to  Do you know the right types of loans for you? to know how to make better borrowing decisions.