How Too Much Debt Can Ruin Your Finances (And How to Avoid It)

The Problem(s) with Too Much Debt

Debt is a common and sometimes necessary part of life. Whether it’s for buying a home, starting a business, or paying for education, debt can help us achieve our goals and dreams. But debt also comes with a cost: interest. And when debt becomes too large or too expensive, it can have serious consequences for our financial well-being and the economy as a whole.

How much debt is too much? There is no definitive answer to this question, as different types of debt have different impacts and risks. However, some general indicators can help us assess whether our debt level is sustainable or problematic. Here are some of the main problems that can arise from having too much debt:

• Higher interest rates: When the demand for borrowing exceeds the supply of lending, interest rates tend to rise. This makes debt more expensive and harder to repay. Higher interest rates also discourage new borrowing and investment, which can slow down economic growth and innovation. For example, the US federal debt is projected to reach $50 trillion by 2030¹, which could put upward pressure on interest rates and crowd out private sector borrowing.
• Diminishing returns: When debt is used productively, it can generate income and growth that exceed the cost of borrowing. However, when debt is used unproductively or excessively, it can create diminishing returns or even negative returns. This means that the additional debt does not contribute to economic output or welfare, but only adds to the interest burden. For example, some studies have found that when the public debt-to-GDP ratio exceeds 90%, it can have a negative effect on economic growth².
• Balance sheet recession: When debt becomes too high relative to income or assets, borrowers may face difficulties in servicing their debt or refinancing their loans. This can lead to defaults, bankruptcies, or forced deleveraging (reducing debt by selling assets or cutting spending). When many borrowers go through this process at the same time, it can create a balance sheet recession, where the aggregate demand and supply in the economy contract due to lower spending and investment. For example, Japan experienced a prolonged balance sheet recession in the 1990s and 2000s after its asset bubble burst³.
• Political challenges: Reducing debt levels can be a painful and unpopular process, especially when it involves raising taxes, cutting spending, or restructuring debt. These measures can face resistance from various interest groups and political parties, who may prefer to maintain the status quo or shift the burden to others. This can create political gridlock, social unrest, or even violence. For example, Greece faced a severe debt crisis in 2010-2015 that triggered austerity measures, bailouts, protests, and riots².

As you can see, having too much debt can pose serious risks and threats to our financial stability and economic prosperity. Therefore, it is important to manage our debt wisely and responsibly, and avoid taking on more debt than we can afford or handle. Here are some tips on how to do that:

• Budget wisely: The first step to managing our debt is to have a clear picture of our income and expenses, and plan our spending accordingly. We should aim to live within our means and save for emergencies and future goals. We should also prioritize paying off high-interest debt first, such as credit cards or payday loans.
• Borrow smartly: The second step to managing our debt is to borrow only when we need to and when we have a clear purpose and plan for repayment. We should compare different options and choose the one that offers the best terms and conditions for our situation. We should also avoid borrowing more than we can repay comfortably or taking on multiple debts at once.
• Monitor regularly: The third step to managing our debt is to keep track of our debt balances and payments, and make adjustments as needed. We should review our credit reports regularly and correct any errors or discrepancies. We should also communicate with our lenders if we face any difficulties or changes in our circumstances, and seek help from reputable sources if we are struggling with debt.

Debt can be a useful tool or a dangerous trap depending on how we use it. By being aware of the problem(s) with too much debt and following these tips on how to manage it effectively, we can improve our financial health and achieve our financial goals.