Debt capacity: What is it, how to calculate, benefits?
Any debt you take on must correspond to the availability you have to respond in time to it, without ignoring your income. Your financial and personal situation will directly influence your availability to pay debts.
Your debt capacity is nothing more than the product of subtracting your total income minus the fixed consumption you have in a month.
Tips before getting into debt
Before taking the decision to get into debt, you need to ask yourself: Do I really need it? Many times we let ourselves be guided by the satisfaction of having something immediately, when really the thing can wait.
This leads us to the next question you should ask yourself: Do I have to get into debt immediately or can I wait? You need to compare the possibility of acquiring a debt at the present time, or if you can wait until you have more resources and not opt for debt.
What adjustments will I have to make to be able to pay back the money? You will most likely have to consider adjustments in the way you deal with future payments and debts, and you may even have to forego some expenses that you would normally afford.
Another aspect that you have to be aware of is whether you can respond in the agreed time to the payment of what is owed, because otherwise you could incur late interest that would make it more difficult for you to pay.
Finally, you must know how to answer this: How much will the actual amount of the debt be? This is crucial because, in most cases, it may happen that you do not take into account the commissions or some interest due to other conditions.
The final amount of the debt ends up being very far from what you can actually afford. Cases like this, which do not correspond to your debt capacity, compromise your financial situation.
How do I calculate my debt capacity?
The financial and banking institutions make this calculation automatically when you want to ask for a loan or credit. However, you can calculate your debt capacity by following this formula.
One of the values you need to know is your net monthly income. Economists say that your debt capacity limit is between 35% and 40% of that income.
You must also know your fixed expenses, these are: rent, food, education, water, electricity, gas and variable expenses such as entertainment, vacations and others.
Having these two data you must subtract the expenses from the income and multiply it by 40%. This result will be your debt capacity. The formula is expressed as follows:
Debt Capacity = (Monthly Income – Fixed Expenses) x 0.40
It is crucial that you set goals that you can meet over time and that you know your income and expenses when opting for a credit or loan. No matter how little money you owe, the interest and conditions of the banks can create a burden that you do not need.
I am Nikesh Mehta, owner and writer of this site.
I’m an analytics and digital marketing professional and also love writing on finance and technology industry during my spare time. I’ve done online course in Financial Markets and Investment Strategy from Indian School of Business. I can be reached at [email protected] or LinkedIn profile.