HOW TO DETERMINE YOUR DEBT CAPACITY

Since credit card companies set debt limits on the amount of credit that they will issue to credit card holders, it would be prudent for people to set their own limits on their total debt capacities. Before immersing yourself in debt, you should determine how much debt you can comfortably afford. In other words, you should set your own debt limit, which is the maximum amount that you can comfortably afford to service the interest payments.
One method of determining your debt limit is to draw up a monthly budget with your cash receipts of income and your cash disbursements for expenses.

The amount left over when monthly cash disbursements are subtracted from monthly receipts is the amount available for debt payments in order to reconcile your checking account. If disbursements are greater than receipts, you cannot afford to take on any new debt, as you will not be able to pay the interest and principal payments without drawing down on your assets. Not everything is as simple or clear-cut as this first approach suggests, which leads to a second approach for determining whether you can afford to take on debt.

This approach involves analyzing your budget to determine where potential trade-offs may lie. By forgoing spending in some areas, you can increase the amount available to finance debt payments.

Cutting vacation and entertainment expenses, for example, can free up funds for servicing debt, but it becomes progressively harder to cut down on necessary types of expenses. The rule of thumb of a 20 percent ceiling on the amount of debt payments to monthly disposable income is a useful guideline. This means that if your monthly disposable income is $2,000, your debt payments should not exceed $400. This does not include your mortgage.

-Monthly cash receipts
-Net monthly income

-Other income Total monthly receipts
-Monthly cash disbursements
-Mortgage/rent Food Household expenses Transportation/auto expenses Child care expenses Savings and investments Other expenses Total monthly disbursements
-Annual expenses
-Taxes Real estate taxes Other taxes Insurance Medical and dental expenses

The greater the level of income, the easier it becomes to support this level of debt. For example, it may be dif.cult for someone with take-home pay of $1,000 per month to support debt payments of $200 per month, whereas someone with disposable income of $3,000 per month may have an easier time supporting debt payments of $600.
The following are the warning signs of taking on too much debt:

• You are unable to save any money.

• You have to cut back on necessary expenses just to make ends meet.

• You only pay the minimum amounts on your credit card bills.

• You are juggling certain payments in order to pay other obligations, which are all due at the same time.

• You are unable to meet payments in emergency situations.

top