The Working Backwards Series: How Much Debt Can I Afford?


The Working Backwards Series?

The Working Backwards Series takes a look at budgeting in each spending category from the standpoint of “how much can I afford given our income, lifestyle and choices?” In this case,  we are talking about a family of four living in Austin, Texas, working toward living in financial freedom, and making $74,000 a year (the average household income in Austin).

What are we trying to accomplish? We want to show what a balanced, sustainable budget looks like, and one way to do that is to “back into” the dollar amount for each budget category given life choices: Raising two children in a two income home.

While we understand we can spend more in categories that mean a lot to us, and each family is different, we want to set expectations that the discipline of a balanced budget, (spending and saving less than we make), requires conscious decisions, sacrifices and tradeoffs to meet our long term goals and desires that include financial freedom.

To see more from the Working Backwards Series, read this previous Working Backward Series post:  Working Backwards Series: How Much Auto Can I Afford? 

Topic For This Post: DEBT


The rich rule over the poor, and the borrower is slave to the lender. Proverbs 22:7

Debt payments are innocuous. Each individual payment is very small in relation to the value or cost of the item purchased. But over time they add up to costing far more than the actual item purchased.  Yet, for many of us, debt seems to be the only way we feel able to have important items like autos, homes, education, vacations and other expensive items. But, the question still stands: How much debt can we afford in our balanced budget?  We have to take a shot at properly budgeting for our debt. To do it right, we need to budget so we can aggressively pay down and eliminate our debt.  For the purposes of this exercise, we will look at a debt budget for consumer debt only. Meaning: credit card debt. You can see from previous “The Backward Series” posts, we have allocated money for other forms of debt payments in their respective budgets, ie. cars, homes, etc. Also, we will assume that this family is trying to eliminate consumer debt completely from their lives while at the same time enjoying themselves in their beautiful city.

What percentage of our budget is allocated to debt payment? In our balanced budget, the total debt budget varies from home to home, depending upon how much debt the family has. For today’s budget exercise, we will start at 5% of our take home total income, or net spendable budget (NSB), to service credit card debt.

What Does That Look Like – The Math

A $74,000/year household income equates to roughly $54,750/year after taxes and charitable donations, or $4,563/month. At 5% of our budget going to debt payments and elimination, that’s roughly $228/month for debt payments or, $2,737/year. That is not very much when you figure the costs of interest and fees eat up a large part of that budget. Let’s take a look at our budget by “backing into” the debt budget to see if we can meet our balanced budget objective:

Let’s take a look at a balanced budget to see if 5% is reasonable: (% of NSB by category)

Housing (All Expenses)           30%

Autos                                       14%

Food                                        12%

Insurance                                  4%

Medical                                     2%

Debt Service                             5%

Savings/Investments              15%

Misc.                                          5%

Entertainment/Clothing           5%

Vacation                                     8%

Total:                                           100% of NSB

So from a budgeting standpoint, we can make a balanced budget with 5% of Net Spendable Budget going toward debt payment, without jeopardizing important budget items like savings, vacations and entertainment, (15%, 8% and 5% respectively), which is healthy.

But the real question is: How much debt can we take on in a given year and still eliminate it by year end? In this case, that is $2,737 for the entire year going toward credit card payments and elimination. The short answer is it is going to be very little. If we assume an average but expensive credit card interest rate and other simplifying assumptions, we find that $2,737 in total debt payments a year equate to roughly only $2,100/year in actual charges on our card. The rest of the money is for interest payments. That’s only about $175/month on our card balance each month. Not very much. So, what does that mean?

What Does That Mean?


Although credit card debt sometimes seems like the American way, it is not a good use of our money. The point is that a balanced budget has little room for servicing credit card debt. Plain and simple. We can’t, and shouldn’t, incur credit card debt month over month. If we have to use a credit card, we should really use it as a debit card where the balance is fully paid off each month. Yet most of us are carrying credit card debt because we are impatient or imprudent.  In fact, the American household average 2015 credit card debt is $15,355! (Nerdwallet) And I believe that is one of the major reasons we have more than 75% of households in America living paycheck to paycheck with no savings for emergencies, retirement, college (for the kids) or any money for dreams like new homes or cars or special events (think vacations, weddings or cars).


What’s The Solution

There are really only a couple acceptable credit card actions to keep us within our budget for debt elimination: 1) Pay cash instead of using a credit card.   2) Use a debit card instead of a credit card. 3) If we use our credit card, use it like a debit card and pay the balance off each month. 4) If we do get a balance on our card, make it a priority to pay the debt off within the year so it does not accumulate into something that becomes insurmountable, (And break the budget).

Final Word

Living in financial freedom does not allow for carrying credit card balances that drain our bank accounts and ruin our budgets. We found here today that a family of four living in Austin Texas can only handle about $228/month in credit card payments, yet, the average American today pays almost six times that amount each month!

Fight to be credit card debt free. Use cash or a debit card. Work hard to be patient and only spend money that you have instead of using the credit card company’s money. If you must use your credit card and develop a balance in your account. Strive to pay it off quickly so that the exception (credit card debt) does not become the rule. Financial freedom is not easy, but it is worth it. Because that money we are not paying credit card companies in the form of interest payments can be better used to fund our goals and dreams.

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The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness

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