How to Determine Debt Capacity

Before you take on new debt, determine how much you can afford to pay without putting yourself in a financial bind. The process of determining the dollar amount you can comfortably pay--known as your debt capacity--can be easily figured. Credit agencies and loan companies follow a similar procedure when deciding whether to loan money to you.

Difficulty: Moderately Easy

Instructions

Things You'll Need:

• Income records
• Expense records
• Calculator
• Paper

1. Gather all of your income and expense records. To determine your debt capacity, it is necessary to have up-to-date information for the equation.

2. List all your monthly sources of income in one column. Include income from wages, business income, child support and alimony received. Total this amount and record it under the heading “Total Monthly Cash Receipts.”

3. Write down all your monthly expenditures in another column. Take some time to think this over, consulting your check register or bank statement, if needed. Include set amounts, such as mortgage payments or rent, car notes and other loans. Estimate variable monthly expenses such as utilities, groceries, childcare, transportation and other household expenses. Total this amount and record it under the heading “Total Monthly Cash Expenses.”

4. Figure your annual expenses. Include payments you make to the IRS, real estate taxes, insurance premiums and an estimated medical expense for your family. Total this amount and record it under the heading “Total Annual Expenses.”

5. Divide the amount of Total Annual Expenses by 12, which will give you a reliable monthly allotment needed to pay your yearly bills. Add this amount to your Total Monthly Cash Expenses and record it under the heading “Final Monthly Expenses.”

6. Subtract your Final Monthly Expenses from your Total Monthly Cash Receipts. Record this amount as your “Monthly Disposable Income.” This is the amount of your debt capacity. This what you have to spend each month after paying your bills.

Tips & Warnings

• Before you take on any new debt, use the accepted rule of thumb that your debt payments for disposable items shouldn’t exceed 20 percent of your Monthly Disposable Income.

[vallain]

on 8/28/2008 This is an important topic as too many people dig themselves into a financial pit that they can't climb out of.