Bank Better, Live Better
The Credit Boot Camp part 5: How much debt can you really afford?05/11/2020
Part of being responsible about debt is knowing how much you can afford, which is what we’re tackling today.
You’ve made your plans and now you just need a loan to make it happen. What’s the next step? The financial savvy will tell you that before applying for credit, you should make sure you can afford any new monthly repayments on top of your current expenses. Yes, the financier will also check your affordability, but it’s your responsibility
to know whether or not you can afford extra credit. Before you slink off thinking it’s too much work, it’s just 3 steps to take.
How much can you really afford?
Your income is the major determining factor, followed by your expenses. The amount of money left after all your financial obligations are deducted, is how much you will be able to afford to repay the loan, says financial journalist Maya Fisher-French.
Step 1: Make a list of your consistent monthly income. It’s the amount after taking away nonrecurring income such as once-off bonuses, variable income such as overtime, and deductions by your employer such as tax, pension contributions and unemployment insurance (your net salary). Your salary slip and bank statement can help you to track your income.
Step 2: List your expenses. These are debt obligations, such as your vehicle instalment, home loan and accounts. Add essential expenses such as food, fuel and electricity. Also take into account the money you pay monthly for things such as family responsibilities, for example contributing to the care of family members or even the community. Bank statements going back 3 to 6 months will show regular and irregular payments and your credit report should state any other debt responsibilities.
Capitec clients can track their spending on their banking app through the ‘track your spend’ feature, which automatically categorises spend into categories like food, transport or communication.
You can also check which small amounts you can cut back on – and calculate the big difference they can make over time! These could include things like your daily takeaway cappuccino or buying lunch every day. Also relook any subscriptions you currently have and are no longer using, such as a gym membership.
Step 3: Subtract your expenses from your income, and what you have left is the amount you could use to repay a loan.
Now you’ve budgeted! All by yourself. To make it even easier, there are many handy tools on the internet (for instance here) to help you stay on top of your budget.
Always plan for the unexpected
“Don’t borrow for the full amount you have left after you deduct your expenses. When you’re calculating your affordability, make sure you’re also planning for emergencies. So try to put an amount aside for unexpected expenses, says Nicolette Mashile, better known as the Financial Fitness Bunny.
“Make sure you have enough money to be able to put some into a savings plan each month. Having money saved for a rainy day means you won’t need to take on more credit.”
What is a debt-to-income ratio?
Although it sounds complicated, it’s actually pretty simple. “Your debt-to-income ratio is the percentage of your gross monthly income (income before any deductions) that goes towards debt repayments,” explains Fisher-French. Credit providers use this ratio to determine how much debt you can realistically afford.
The ratio is calculated by dividing your recurring monthly debt by your gross monthly income and is expressed as a percentage. Ideally, you want that percentage to be less than 36%.
Okay, but what are recurring monthly debts? Those are the debt payments you need to make every month, such as your rent, credit card, student loan or vehicle finance.
Let’s flex our brains a bit and work through an example. Let’s assume you pay R5 000 for rent, R2 000 for your car and R1 000 for the rest of your debts each month. Your total monthly debt payments would be R8 000.
If your gross income for the month is R25 000, your debt-to-income ratio would be 32% (R8 000/R25 000 = 0.32). If your gross income is lower, say R20 000, your debt-to-income ratio would be 40% (R8 000/R20 000 = 0.4).
How to find the best credit offer
- Look at your budget and affordability to see if you can afford credit repayments
- Do your research. Not all credit providers charge the same. You need to compare credit options and decide what will work for you. You must be completely honest with the credit provider about your finances when applying for credit. Don’t be tempted to take on more than you need
- Look for any hidden costs and double-check the fees and charges. “Make sure you understand the small print. It’s important to always compare the total cost of credit when comparing offers, which includes all fees, not just the interest rate offered.” says Mashile. “Have you got questions? Ask!”
- Make sure the credit provider is reputable and registered. Why? “Because it means they will comply with the law and respect and protect your rights as a consumer,” says Fisher-French
- Once you’ve chosen a product and credit provider, go back to your budget and check: can you afford the monthly instalment shown on the quote? Will you still have enough saved for emergencies? Answered yes to both questions? Then you can accept your credit offer
How to apply for credit
You can apply for credit online or in person at a bank. Your offer is based on your affordability and credit profile. Typically, a credit provider looks at:
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business owners can now apply for credit
If you own or are a member/shareholder/director of an NPO, a trust, CC or a public/private company and earn a monthly salary, you may qualify for a loan.