# Is it foolish to borrow 2.5X income? [closed]

I base this question from USA Today, which claims that median household income is \$59,000 and average household debt is \$137,000. They say:

suggesting that many Americans are living beyond their means.

It looks like a lot of this is debt is for a home or education. I don't see how this proves people are living beyond their means if they're borrowing for education and a home. Is it foolish to borrow 2.5 times one's income in that it indicates one is living beyond their means (what would be more reasonable)?

• I don’t think that it is possible to draw any conclusions on this. Average household figures will include people on welfare and other types of benefits. Also it will include renting as well as home-owners. To get a clear view the numbers should be cleaned up, so that it is possible to see how the debt is spend. It is not at all unreasonable to have debt 2.5x your annual income if it e.g. is put into a mortgage on a house. If you have a debt of 2.5x your annual income and spend it on goods and luxury items, yes then it is alarming. – ssn Feb 14 '18 at 15:27
• There is no Average American, and the arithmetic mean (fancy word for "average") is a poor method of determining "typicalness", since it can easily be distorted by a small number of outliers. – RonJohn Feb 14 '18 at 15:27
• Comparing median income to average debt is not meaningful. Comparing the median person's income to the median person's debt would be somewhat more useful as a personal finance discussion. Comparing per capita GDP (average income) to per capita debt (average debt) would be very useful from a macroeconomics perspective. – user662852 Feb 14 '18 at 15:43
• Combining the "average" of one stat and the "median" of another is a practice ripe for questionable conclusions. – whatsisname Feb 14 '18 at 16:15
• It would be better to look at debt minus assets. If you owe \$137K on a mortgage for a house worth \$206K (US median home value), and have \$59K income, the situation isn't all that dire. – Mark Plotnick Feb 14 '18 at 19:43

This is mainly opinion based, but I will take a shot at it.

tl;dr: It depends.

Remember that household income includes all people that live inside the house and earn a wage. In my own case, that would include my daughter who earns about 10k per year working part time while in school. Generally speaking though, this is two adults that are heads of the household.

If a person borrowed heavily to obtain an education where they make anything less than 75K per year then it was probably foolish. There are many jobs that earn that and more that do not require a college education. A person would be far better off working while in school instead of borrowing for a relatively low income.

Borrowing to purchase cars, which I think is a very large contributes to this figure, is almost always foolish. Many people could become multimillionaires if they invested the money saved by eschewing the practice of trading in their cars every 5-6 years in favor of something new.

I feel that home purchasing tends to be wise if a person buys "correctly". That is with an emergency fund in place, sufficient down payment, and an affordable home.

So there is probably some wisdom in having about 2x income in debt because of a home (on average), but that is about it.

• Overbuying (whether it be cars, homes or education) is a unnecessary added millstone around many people's necks. – RonJohn Feb 14 '18 at 15:31
• The idea that borrowing "heavily to obtain an education where they make anything less than 75K per year" is foolish is just plain wrong. Maybe if you live on in California one of the major east coast cities this applies, but not if you live somewhere with much lower cost of living. not to mention the value of a good education beyond just securing a job – mao47 Feb 14 '18 at 16:05
• @mao47 It doesn't matter how is the cost of living in the place you're going to work if your job isn't even able to pay your student loans. Getting a loan now to pick a very badly paid job in the future isn't a wise move. A former GF is still paying her student loans five years after finishing college with monthly payments of \$900, and she still has five more years to go. Her monthly salary is around \$700. She has to consistently borrow money from everyone around her to just pay off her loans. The worst part? That's a good salary for her field... – T. Sar Feb 14 '18 at 16:57
• @mao47 I live in a pretty low cost of living area, so that is my perspective. However the main point is that it is foolish to borrow heavily to obtain such a job, nothing wrong with going slower and obtaining your education while cash flowing. There is no rush if there is no income reward waiting to be had. – Pete B. Feb 14 '18 at 17:08
• @T.Sar the answer said less than 75k. 700/month is only 8400/year and seems very exceptional, and is well below minimum wage for full time work. My comment was more tailored to 40-50k full time salaried jobs, which should be able to easily afford 900/month in loan payments, and are still very far below the answer's minimum for non-"foolish" student loans. – mao47 Feb 14 '18 at 17:42

No it is not foolish. Borrowing money is based more in ones ability to repay what was borrowed and ones ability to use that borrowed money to a good effect. The size of the loan relative to income is only one factor among many.

Mortgages are a good example. If the borrower earns \$60k/year takes out a mortgage for \$150k and is then able to pay their mortgage and home maintenance costs instead of paying rent, that borrower is better off. They are now making payments on an asset that builds equity instead of renting. Their monthly cash outflow has not changed dramatically.

A counter example: A renter is renting at \$500/month. Gets a mortgage that requires them to pay \$2000/month even though their monthly budget and spending habits cannot easily afford that new higher rate. This makes the loan a bad idea, they cannot use the advantages of building equity if they end up missing payments or being foreclosed on.

• Mortgages are a mixed bag. You pay interest on the principal, normally the interest itself is greater than the appreciation in the earlier years. Add maintenance, taxes, and other fees and the equation can become even more tilted. Renters can be in a better financial position because their landlord can benefit from economies of scale. – Lan Feb 14 '18 at 15:41
• @Lan you are 100% correct. Even the short examples you and I posted have a lot of variables and nuance. I hope this helps answer the OPs question by just showing how many ways there are to crunch the numbers and factor in individual needs of the borrower. – Freiheit Feb 14 '18 at 15:52

First, one should understand that median (half are above, half below) is different from average (where a few billionaires living in one's town makes average wealth look huge).

In good mortgage underwriting, one's home monthly cost, including mortgage payment, insurance, and property tax should not exceed 28% of monthly gross income. Let's drop that to 22% for just the mortgage. At 4.5%, \$1081 will buy you \$213K in a mortgage (add a good down payment, and you have a \$260K house).

This is 3.61 times income. One can argue whether common practice for approved mortgage underwriting is wise, but keep in mind, the real estate crash of 2008 would have been completely avoided had all lenders stuck to the 28% income ratio, along with a 20% down requirement.

Compared to the 3.6, 2.5 seems very non-foolish.

Disclosure - When we bought our house, we borrowed almost exactly 2X our income. We wanted the monthly cost to be far lower than 28% to afford childcare and saving for college.

My answer completely assumes the bulk of the 2.5X is mortgage. If I owed even 5-10% of my old income on credit card debt I kept from month to month, that would be "bad".

• +1 thanks @JoeTaxpayer. `In good mortgage underwriting, one's home monthly cost, including mortgage payment, insurance, and property tax should not exceed 28% of monthly gross income.` This is very similar to what I've heard suggested from bankers about mortgage to income. 2.5 times does seem fairly reasonable. – Ms Jackson Feb 14 '18 at 17:24

As Dave Ramsay says, "your most valuable wealth building tool is your income".

Let's do some napkin math. We'll posit that the average cost of debt for individuals is 5%. (Just making that number up.) If a household has 2.5x their income in debt, that means 12.5% of their income is being spent to service debt if they maintain the debt over a year. That's 7.5K on a 60K income.

Using any of the online calculators, if someone from age 30 to age 65 put 7.5K into retirement savings and received average annualized returns of 7%, they'd retire with 961,000.

So it seems stupid.

• I do not disagree but that math still requires context. For example, if I invest instead of paying debt but still pay rent then I am potentially throwing that rent money away. Whereas if I take on debt for a mortgage with reasonable terms I can still invest AND retire with a house I own outright. Paying debt and investing is not in line with the Ramsey system but it is a perfectly valid option. – Freiheit Feb 14 '18 at 15:42
• You completely ignore the fact that people need a place to live. If it was for an investment point of view only, then your argument might make sense - but it is not. Consider if your rent is also 7.5k a year (to make things super simple). In your scenario 7.5k is thrown out the window (because it is used to pay rent) and another 7.5k is invested at 7%. Consider now the home owner scenario: 7.5k to pay debt (=decreasing over time when amortizing) - then place the remaining 7.5k (increasing in time) in investments and amortization. Which scenario leaves you with the most equity when you retire? – ssn Feb 14 '18 at 19:58
• It’s common for rent to be 1/4 of one's income. Those renters would be happy to swap their situation for a house payment of 7.5% of income. What does The David quote even mean as an introduction to your answer? Non-sequitor – JTP - Apologise to Monica Feb 14 '18 at 20:48
• @JoeTaxpayer My answer is that the interest on the debt is 25% higher than the recommended savings rate for retirement. Someone who tapered their spending (ex cheaper home, no CC debt) could take the money they won't spend on servicing debt towards savings. – Lan Feb 15 '18 at 17:24
• @ssn Renters don't pay as much for rent as home owners do for house ownership. Landlords get economies of scale and cover expenses. Also, that 7.5K in debt servicing is not solely the home. And even with the home, the average home in the USA/Canada has grown by 1000 sq/ft over the last hundred years. A person can get a cheaper home. – Lan Feb 15 '18 at 17:28

Keep in mind that those numbers can be dramatically problematic, because they are averages and median.

For example, imagine these households:

• 10 households making \$59k/year with 59k mortgage debt
• 1 household making \$300k/year with a \$1M mortgage living in SF

Those numbers add up to be the same as those in your OP (59k median income, 159k average debt).

It's worth pointing out that in higher cost of living areas, people will be able to sustain higher incomes as well as higher mortgages compared to those incomes with lower cost of living areas.

Another point is that the numbers in that article make no sense. Overall average household debt is \$137k/household yet... average household mortgage debt is \$182k and student loans of \$50k?

I would be cautious trusting an article that at the very best is careless with its use of statistics and data and at worst, deliberately manipulating them to lead to incorrect results.

• \$1.3M at \$190k? No way. That's \$10k/mo after taxes to \$6k in mortgage cost, \$1354 in taxes, probably \$500 for the HOA. 75-80% of post-tax income to housing? I don't think even the craziest of banks at the height of the subprime mortgage fiasco would have approved that. – Kevin Feb 14 '18 at 18:43
• @Kevin the examples are to illustrate the point. You can change the numbers however you want, the overall point remains. – enderland Feb 14 '18 at 19:03
• @Kevin given the purpose of the example, I don't think it's necessary for OA to spit shine the numbers. Don't be picayune, also SF is too old a city, it was built out before the HOA scourge arrived. – Harper - Reinstate Monica Feb 14 '18 at 23:04
• The median income in that example would be 40k, not 59k, but you can put those first 10 incomes at 59k to get the right numbers for your example. Of course mixing up average (aka mean) and median of anything is usually meaningless. – Sumyrda - remember Monica Feb 15 '18 at 7:29
• @Sumyrda oooh I didn't even notice that, it makes the article even more misleading. – enderland Feb 15 '18 at 14:37

The answer depends on a number of other factors which aren't mentioned, such as what the borrowed money is used for, and whether the borrower has assets to cover the debt.

For instance, the 2.5X debt/income ratio was almost exactly my situation when I bought my current house, about 20 years ago. I had no other debts other than the mortgage, and the mortgage payments & expenses were less than rent for a place that I would have chosen to live in. (Then: nowadays you can't find a 1-bedroom apartment in the cheap parts of town for that.)

Now it's nearly paid off, and in the current market would sell for 2-3 times what I paid. Also, I have much more than the outstanding mortgage balance in investments, which over the long term have earned a good deal more than the mortgage interest rate.

I suggest that in cases like mine, people are not being foolish, and not living beyond their income. Buying a house with a mortgage is often a sound financial decision. You really need to need non-mortgage debt numbers, and asset to debt ratio, for any sound conclusion.

PS: Another factor here is what is being done with the borrowed money. If I have a mortgage at 4%, and (more than) the outstanding balance in investments that are returning around 8%, it would seem foolish NOT to keep the debt :-)

• Good point about assets. – Ms Jackson Feb 14 '18 at 20:33
• @Ms Jackson: And to carry the point even further, there have been some years in those 20 when my outstanding mortgage balance was 5-10X my income (or at least realized income, not counting market appreciation of stocks & funds sheltered within 401k/IRA), because I chose to do things like return to school for a PhD... – jamesqf Feb 15 '18 at 4:54

TL/DR: It depends on the kind of debt (a home mortgage eliminates the need for rent, for example), the interest rate, the length of the loan, and whether it is tax deductible.

TWO PARTICULAR EXAMPLES:

1. Let's suppose you make \$100,000/year. Let's suppose you borrow \$250,000 to buy a house. A 30 year mortgage is around \$1200 per month. About 800 is interest (at the beginning) and 400 is principal.

\$100,000 per year would make you pay less than \$30,000 in taxes, so you have \$70,000, so you have \$5,800 per month. Subtracting your mortgage payment you have \$4,600, even including property tax you should still have over \$4,000.

Can you afford to repay the debt? Yes, you are left with \$4,000, and now you are rent free. Also, you get a tax deduction on the interest, so, you actually get a big check back comes April if you decide not to lower your taxes.

Bottom line, if your debt is for a home, 2.5 your income is definitely sustainable.

2. Let's say you have, instead, a \$250,000 debt in credit cards at 21% interest. You would have to pay 2% of your balance just to make the monthly minimum payment. That is \$5,000, or \$60,000/year that is not tax deductible. So, after taxes, you are left with less than \$1000 (maybe \$800) that you need to use to pay your rent and all other expenses. Can you afford to repay the debt? No!

As other people have said, it depends on the debt (a home mortgage eliminates the need for rent, for example), the interest rate, the length of the loan, and whether it is tax deductible.

Not foolish at all if you borrow any amount to buy a rapidly-appreciating asset.

Extremely foolish to borrow 2.5 years' income to buy depreciating assets or consumables.

It sounds like at least part of what you are asking is actually this: Given that median household income is \$59,600 and average household debt is \$137,000, does it follow that many Americans are living beyond their means?

The answer is no. Imagine a country in which there are 100 households, all with income of \$59,600. Imagine that 99 of these households have zero debt, and one has debt of \$13,700,000. Then, assuming "average" means the arithmetic mean, median income is \$59,600 and average debt is \$137,000, but it is not at all true that "many" people in the country are living beyond their means. There is one person with a lot of debt and everyone else is fine. (Even if we use "average" to mean "median" in both cases, you can concoct many situations with debt and income distributed in various ways across the population.)

That is a silly example, but my point is to say that we should begin by questioning whether the claim by USA Today ("many Americans are living beyond their means") is actually "suggested" by those numbers alone. It is not. Never mind whether it's "foolish" to take on such-and-such amount of debt; the point is that those numbers don't even address the question of how many people are taking on debt that is 2.5 times their income. Even if they did, that would not tell us whether anyone is "living beyond their means". "Living beyond your means" generally means having expenses greater than your income, about which the given numbers say little or nothing.

Now, if we combine the article's numbers with some other reasonable assumptions (about the kinds of debt people tend to take on, the way income and debt are distributed, etc.), you might be able to make a ballpark estimate of the typical (note I don't say "average") debt-to-income ratio. And if we do that, then, as others have pointed out, we can say that the question of whether a given debt-to-income ratio is foolish depends on many factors.

My answer is just pointing out that the article itself is playing somewhat fast and loose with logic and arithmetic, moving from two separate statistics about income and debt to a claim about "many" people "living beyond their means" --- an inference for which those statistics provide at best only rudimentary support.

I denmark we are having a rule of thumb going like. You can borrow around 3 times your income. So the number cant be compared to US, but the logic behind whats smart is the same i think.

Then comes all the other stuff.

What other loans do you have. How much money do you spend on living, vacations, food and all that.

Another rule of thumb, when the banks are approving you for a lone. They are estimating how much you may loan based on there being 11000DKK(~1800\$)/Month for a pair living together, and adding 2000DKK (~300\$) for every kid after loan and other fixed monthly costs. (This is also where the other rule of thumb is derived from).

Then again, comes the exceptions. Its all about how you present your private financials. Knowing that they need to fit the budget explained above, good sales people are convincing the bank to go even higher. (in denmark the bank first have to approve the loan using normal rates - then when approved you can select other types of loads that cost you less).

There are cases where peolpe lone 4x income, and even higher. Last week a bank representive told me that our budget could work (this was above 4) but when above 4 there was other rules that applied, as there are loan types that we would not be allowed to use.

A short note here, we have decided not to load 4x times our income as we concluded our self that it would be to high a risk. Waiting and saving some more.