When people start getting deep into debt, the process is often accompanied by a large helping of denial. That is, as their debt grows larger and more threatening, they begin to rationalize why it’s not so bad. This is when it becomes important to recognize important debt thresholds – clearly identifiable metrics that should absolutely begin flashing warning signs.
One of these thresholds is when your credit card debts exceed your annual income. It’s one of the best indicators that your debt situation has passed the point of no return, and drastic action is necessary.
It’s easy enough to figure out when you reach this point. Total up all of the credit card debts, and then compare the total to your annual income. If your credit card debts are higher than your annual income – or even close to it – then you have reached a crisis point with your debt. That’s true because there will be no easy options to getting out of debt from that point forward.
The Math When Your Credit Card Debts Exceed Your Annual Income
By the time your credit card debt reaches a point where it’s at least equal with your annual income, it has already begun to become a serious strain on your finances.
As an example, let’s say that your annual income is $50,000, and your total credit card debt has recently reached the same point – $50,000. The problem now is that the ability to service that much debt on your income is almost impossible.
Given that credit card companies typically require a minimum monthly payment of at least 2% of the outstanding balance, you are now required to pay at least $1,000 per month for your credit card debts.
With an annual income of $50,000, your monthly income is $4,167. With credit card payments totaling over $1,000 per month, you are now paying close to 25% of your income to cover the minimum monthly credit card payments.
It’s likely that your monthly credit card payments are comparable to your monthly housing expense. But you probably also have a car loan, as well as income and FICA taxes, health insurance, auto insurance, life insurance, and a host of other expenses.
What this means is that while you may be able to barely afford to pay the minimum on your credit cards, there’s little left over to make a serious dent in the amount that you owe. You may even find yourself just getting by each month, but with nothing left over for savings or for serious debt reduction. You’re now caught in a vicious financial cycle.
The Effect of High Credit Card Balances on Your Credit Score
As credit card balances increase, they begin to have an effect on your credit score. One of the primary factors in determining credit scores is credit utilization. In fact, it accounts for 30% of your credit score, second only to your payment history.
As the amount of money that you owe grows – and moves closer to the total amount of credit that you have available to you – your credit utilization ratio increases. As it does, your credit score declines.
Ultimately, a lower credit score means that your ability to get fresh credit will be seriously limited. It also holds open the very real possibility that the interest rates on your existing credit cards could begin to increase.
Should that happen, more of your monthly credit card payments will go to interest – keeping you deep in debt far longer. Still another possibility is that the credit card companies will begin raising the minimum monthly payments. An increase from 2% of the outstanding balance, to 2.5% will turn a $1,000 minimum monthly payment into $1,250.
If you are struggling to pay $1,000, the increase to $1,250 could force you into default.
You’re Almost Certainly Technically Bankrupt
If you owe that kind of money, it’s highly likely that you have very little in the way of savings and investments. High credit card balances and a lack of savings are common traveling companions.
If you have a lot of debt, but very little in savings, you are considered to be technically bankrupt. That’s a condition in which your liabilities are higher than your assets. Even if you don’t file for legal bankruptcy protection, you are still in a bankrupt state. That is to say that if liquidated all of your assets, there wouldn’t be enough money available to pay off your debts completely.
Unfortunately, it’s not uncommon for people to live in a state of technical bankruptcy for many years. It’s a very uncomfortable and highly stressful way to live.
What Are Your Chances of Getting Out from Under that Much Debt?
If your credit card debts exceed your annual income, the likelihood of you getting out of debt is remote. A debt of that size is simply too difficult to eliminate at that income level.
If you can only afford to make the minimum monthly payment on your credit cards, you will stay deep in debt for many years. But if you are constantly borrowing to pay for living expenses that your income can’t cover, your credit card debt will get even higher – and so will the monthly payment.
It’s a Catch-22 that few people have the ability and commitment to win. It’s also a one-way ticket to bankruptcy court.
The Fastest Route Out of Very High Debt
If your credit card debts reach the point where they exceed your annual income – or even come close to it – it’s time for a serious heart-to-heart talk – with yourself!
Seriously evaluate your chances of paying off that much debt with the income you have. If you have any doubt that you can, it’s time to get professional help. Credit card debt of such proportions never just goes away. There’s a day of reckoning, and you can choose either to be proactive and take control of the situation, or ignore the problem until you end up in bankruptcy.
If you decide to take a proactive route, plan to contact a law firm that specializes in credit. They can help you negotiate your debt situation so that you can begin getting out of debt in a way that’s affordable for you. And along the way, you can avoid the painful bankruptcy experience, and the life disruption that it causes.
But don’t wait too long to act. Runaway credit card debt controls your life. Until you begin to seriously reverse the trend, the outcome is all too predictable, and completely unpleasant. Don’t wait until you run out of options to act.