Thursday, September 15, 2011

How Much Personal Debt Is OK?

Don't Wait To Hit YOUR Debt Wall!

Personal credit is still very easy to get, and there is a whole economy that depends on consuming goods we don`t have the cash to pay for. Low low interest rates also make buying things on credit seem appealing. Our whole society has been caught up in the idea that we have to have the newest, the best the flashiest if we ever hope to keep up with the Jones.

A large percentage of Canadians would be in serious financial difficulty if they were to miss their next pay cheque and have very little savings they can fall back on if they lose their source of income. All those things we buy on credit may make us feel good for a time, but when those payments start to add up and we find ourselves worrying about how to pay our bills, our health can start to suffer.



How Much Debt Is Manageable?

If you want to know how much debt you can safely manage without putting yourself into the position of hitting Your Debt Wall the following advice should be helpful. Of course knowing how much debt you can safely handle, is one thing but having the discipline to stay within that limit is something you will have to work at.

Banks and other lending institutions all pretty much use the following formula when determining if you qualify for the loan you are asking for. They use the rule that no more than 40% of your 'Gross' monthly income should be needed to pay for your housing (includes principle, interest, taxes and heat), credit card and other loan monthly payment and any car payments you may have. Once your total debt service ratio hits 40% you are no longer considered a candidate to borrow any more funds. The banks are not just being meanies, but they know that when that ratio exceeds 40% you have put yourself in an unhealthy financial position which will likely sooner or later cause you to default on some of your debts.

Unfortunately many merchants don't hold you to the same standard and companies interested in selling you that new couch, or big screen TV or even an new car will allow you to become more indebted than what you will likely be able to handle.

A Few Examples To Consider

If your gross annual income is $35,000 your monthly gross income would be $2,916.00. At this level of income you should have no more than $1,166.40 owing when you add up your housing (include your mortgage or rent payment plus cost of heat), your monthly credit card payments, all of your loan payments and any car payment you may have.

If your gross annual income is $50,000.00 your monthly gross income would be $4,166.00. At this level of income you should have no more than $1,666.40 owing when you add up your housing (include your mortgage or rent payment plus cost of heat), your monthly credit card payments, all of your loan payments and any car payment you may have.

If your gross annual income is $60,000.00 your monthly gross income would be $5,000.00. At this level of income you should have no more than $2,000.00 owing when you add up your housing (include your mortgage or rent payment plus cost of heat), your monthly credit card payments, all of your loan payments and any car payment you may have.

Items Not Included In The Above Examples

First remember that the above formula is based on your 'gross' monthly income, which is not the actual number of dollars you get paid after the government taxes are taken off, and your pension plan payments and unemployment insurance payment etc. You can usually consider at least 23% of your gross income will be deducted before you are paid. For example if your gross monthly income is $4,166.00 your net income will be in the order of $3,207.00 which means that if you are paying 40% of your gross on the above three items the money left for all other expenses would be $1540.60.

Some of those other expenses might include:

  • Food
  • Clothing
  • Car Insurance
  • Car Repair
  • Gifts
  • Meals Out
  • Movie rentals
  • Vacations
  • School supplies
  • School field trips
  • Dental
  • Eye Glasses
  • Gasoline
  • Cable
  • Telephone
  • Cell Phone
  • Internet Connection
  • Hydro
  • User Fees




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