3 Basic Debt-to-Income Ratios for Healthy Living
How much debt you currently have - car loan, housing loan, and credit card debt?
Things seem to be pretty good now - KLSE is on an incredible continuous climb, property market is getting hotter, and banks are eager to lend out money for without asking too many questions.
We are now living in a credit-friendly heaven, it seem.But consider this:
- Half of the some 3,000 individuals enrolled in Bank Negara’s debt management programme because of credit card woes.
- Total credit card outstanding balance jumped to RM19.8bil at the end of 2006 with an annual growth rate of 19%.
- Household debts grew an average 15.9% in the past 6 years with total outstanding loan at RM394.8bil as at end-2006.
As a growing number of people get carry away in the borrowing fenzy, this is a good time to assess your finances and determine how much debt is too much by doing the following small exercises.
The 30% rule of thumb
Add up your credit card debt if you have any, car loan and other consumer loans (excluding housing loan) and divide the total by your annual gross income (before tax). Ideally you want that figure to below 30%. That means if one currently earning RM50,000 a year, the total consumer debt should be less than RM15,000, or an average of RM1,250 a month. If the number is close or more than 30%, it is time do some soul searching to determine why borrows so much. This may involved some ‘down grading’ such as changing to a smaller car and adopts a more prudent lifestyle. People who take on too much consumer debt run the risk of hurting their credit and they can potentially wind up in bankruptcy proceedings.
The 28% House Rule
By any measurements, housing loan is the biggest loan for most of the people (including re-financing, over draft). To assess how much housing loan cab one afford, financial experts recommend 28% of gross income (before tax). This is how it works: no more than 28% of gross monthly income should go toward house-related debt (including various annual fees and insurance).
A person who takes home RM4,000 a month (after taxes), for example, ideally want the monthly payment for house loan not to exceed $1,120.
The 36% Final Rule
Monthly debt payments for everything — house, credit cards, car loans, student loans, etc. — shouldn’t be above 36% of gross monthly income. After allocated 28% of monthly income on housing loan, there is only 8% left for the remainder of all other debt payments. Therefore for someone who earns $4,000 a month, 8% would come to $320. Many car payments are more than that, sadly!
Conclusion
Called debt-to-income ratios, these percentages are maximums and are generally used to measure healthy living. Those who spend 36% or more of their income on servicing various debts are facing a high risk of being financially unstable, or at best, living under constant financial stress.