Study: Americans Are Spending 9% of Their Income on Debt

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Study: Americans Are Spending 9% of Their Income on Debt

The Motley Fool 18/12/2020 14:00:00 Christy Bieber

Study: Americans Are Spending 9% of Their Income on Debt

a man that is standing in the water: The word Debt on a wrecking ball swinging toward a man running away.

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According to recent research from The Ascent, households across America spent around 8.69% of their income on paying debt in the second quarter of 2020. That's down from 9.69% during the same time period last year, but it's still quite a bit of money. In fact, when you consider that most experts recommend you spend 30% or less of your income for housing and save 20%, stacking almost 10% more in debt on top of that means you'd be left with just 40% of household funds for everything else.

Of course, household debt isn't distributed evenly across households. Some devote more of their money to paying creditors while others spend much less. If you include a mortgage payment in your total household debt, 8.69% would be a really low number, while devoting 9% of income to credit cards could mean you're in a lot of financial trouble.

What the data does show, though, is that people are continuing to borrow a lot of money, although less than in the past. And the more money you've committed to paying your creditors, the less you'll have to live on in the future -- which can increase the amount you subsequently have to borrow.

If you've promised your creditors close to 10% of your paychecks for the next few years, for example, that's kind of like taking a 10% pay cut because you've taken those funds away from your future self.

How much of your income should go to household debt?

Ideally, very little of your income should go to household debt. There are a few exceptions. It can make sense to take out a mortgage, as long as it's an affordable one and you've made sure you're financially ready for homeownership. And taking on debt for endeavors that grow your net worth can be smart, such as borrowing to start a business if you have a solid plan to become profitable.

But as far as high-interest debt to buy depreciating assets, the ideal percentage of your household income that should go to this is 0%. Charging goods or services on a credit card should be a last resort saved for dire emergencies, while even a personal loan should be used for necessities only (although these tend to have lower rates than credit cards, so they can be a better way to borrow if need be).

By avoiding debt that doesn't help you grow wealthier, you won't be committed to a monthly obligation, so you can keep your expenses lower and use your limited funds to accomplish better and more important goals.

What if you're spending too much of your income on debt right now?

If too much of your monthly income goes toward your creditors, there are a few steps you can take to change that.

The first, and quickest, is to refinance your debt. If you have high-interest debt, such as a credit card with an APR of 15% or 20%, consider using a balance transfer credit card or personal loan to reduce the rate you're paying. This can make debt payoff much more affordable over time and can ensure you waste less of your money on interest over the repayment process.

You should also make a plan to pay off your debt ASAP by paying more than the minimum due. This doesn't generally make sense for a mortgage loan since interest rates are extremely low right now and you can earn a better return on your money by investing it. But for other kinds of debt, aggressively paying it down can be the best thing to improve your cash flow and your long-term financial situation.

For many people, paying the minimums on all debt and then making extra monthly payments on loans with the highest interest rates makes sense as this can save you the most in interest. However, others do better by paying off their loans with the smallest balance first so they can score quick wins and stay motivated.

Decide which of these debt repayment approaches seems best for your situation and then make a concrete plan for how much extra to pay each month to get rid of your debt balance so you don't have to waste 9% (or any amount) of your hard-earned money on making creditors richer.

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