How much debt should you have

It's important to take on debts for the things that help you live comfortably. Almost no one buys a home, or even a used car, with cash. That's what banks are for, and there's no shame in carrying debt for reasons that contribute stability to your life or make it possible to earn a good living.

But too much debt, or simply a little too much of the wrong kind, invites disaster. Debt interferes insidiously with your ability to save and to invest. It's the opposite of wealth building, since you have to pay for the use of someone else's money.

THE RULES
Good debt vs. bad debt, and how much of each to have
Simply put, fixed-rate loans at competitive rates for assets that appreciate, like a home or education, are your best kinds of debt. (Rate might not be low now, but you can always refinance if they drop, no reason to put off borrowing over a point or two.) Borrowing to buy a new car is always a loss, but there are arguments (repairs, longevity of the vehicle) for buying new, though the car will lose 40% of its value in the first couple of years of ownership. Bad debt, however, is borrowing simply to consume, and the problem is compounded if you borrowed at high rates or rates likely to adjust upward with little notice, ie, on a credit card. A new coat if you need it to keep warm is arguably reasonable. New shoes, a new sweater, lunch out, sunglasses and nifty digital camera on a 19% interest rate credit card you are very unlikely to pay down within the month is suicidal debt. Again, it's not about the needless interest you will pay, it's about the ground you lose by not investing that money -- the purchases and the interest -- to begin with. Whatever you spend, add a zero, and that's how much potential retirement income you just burned. Spent a grand on a trip out of town? That's $10,000 you will not have for retirement.

Calculate your debt-to-income ratio for a good sense of your limits
Our favorite debt level for revolving or credit card debts is zero. If you can't pay it off in the same month, cut up that card pronto! It's literally a black hole in your financial life. You will be safer and happier using cash or checks. One way to measure the rest of your debts -- like home, car or education loans -- is to figure your debt-to-income ratio. On a computer spreadsheet or a simple scrap of paper, write down every monthly debt payment you make, like mortgage payments, credit card bills (use double the minimum payment), child support, car loans, student debt. Then add up your take-home pay -- the actual cash amount you get -- and any additional income like interest earned or annual bonuses divided by 12 months, alimony, etc. Divide the income by the debt, and look at the result. Simple rule of thumb: Under 30%, you're golden. Over 40%, uh-oh.

Breaking down the debt levels further
You will hear a lot of calculations about how much of each kind of debt to carry, but here's the two that matter. Your mortgage bills, including taxes and insurance in escrow, cannot exceed 28% of income, and your total debt cannot exceed 36% of income. If you break either of these limits, expect trouble to find you fast. As for credit card and revolving consumer debt, make that a huge priority. Consolidate, sell a car, take a part-time job, do whatever it takes to erase credit card debts as fast as you can manage. Once that's under control (and concurrently if you can manage it), put aside at least three months of income into a rainy day fund. This will prevent you from borrowing under duress at high rates, should your car break down or unexpected health issues jack up spending. If you meet the previously explained basic limits and have no short-term debts hanging, it's time to invest. Ideally, as you age, your debt load will diminish as you pay off a house and your kids grow up and move out on their own. But it won't help to have zero debts at 60 if you blew the chance to invest steadily over the years for your own coming retirement. So, carry the good debt (at the lowest rate you can find) and invest often and early.