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Course 2: Your Situation
Lesson A: Debt Load

Common Question’s

What is a “debt load?” What is a safe amount of credit for me to carry? How do
creditors find out what my debt load is?

Debt to Income Ratio
Before extending credit to you, lenders analyze your income and your expenses to decide whether you have too much debt. This debt to income ratio is figured with monthly amounts and reveals how good (or bad) your total financial picture is. To figure this ratio for yourself, add all of your non-housing monthly payments. Then compare that total with your total gross annual wages divided by 12. If you don’t have fixed monthly payments on revolving debts such as credit cards, estimate your monthly payments at 4% of the total amount you owe.

When you divide your monthly debt payments by your total monthly income, you will get your monthly nonhousing debt to income ratio. It’s usually expressed as a percentage so move the decimal point 2 places to the right and add the “%” sign.

Example: Bob’s Home Loan
Bob is applying for a short-term, unsecured loan. His gross monthly income is $2,000. His monthly debt (excluding his housing payments) is $500. That means that his credit cards, gasoline cards and car payments amount to 25% of his income. And the mortgage payment hasn’t been added to that.

Debt $ 500
Income $2,000

If Bob decided to apply for a home loan, his lender would look at both his non-housing debt and her total monthly debt which includes his housing payments. They call these his “ratios.” His income is $2,000, his nonhousing debt is $500, and he is applying for a mortgage loan that would cost his $350/month. This makes his total debt $850, including housing payments. Now his housing plus other debt ratio is 42.5%. This debt is generally too high for most mortgage loans, and Bob will have to pay off some of his other debts to qualify for a mortgage loan.

Debt $ 850
Income $2,000

28/36 Rule
A conservative rule of thumb for mortgage debt is the “28/36 Rule”. This means that your non-housing debt shouldn’t exceed 28% of your gross (your total) income and your total debt — consumer debt plus housing debt — shouldn’t exceed 36% of your gross income.

Other Considerations
In determining your own debt load limit you can use a rule of thumb such as the 28/36 rule, but you must also consider:

• The stability of your income.
• Your other regular expenses.
• Your need for cash from month to month.
• All of your personal needs and wants.
• The “smell test:” Are you comfortable with this amount of debt?
• The changes in your cash needs as you and your household grow older.

Remember that your debt spends your future income. And you have less money now to do things you want to do because you must pay for items you've already bought, and in many cases, already discarded.

Begin the habit of regular savings. It's much cheaper to save for an item first than to buy it on credit. Keep your future debt load reasonable.

Exercise
Do a monthly debt load analysis by listing your income and expenses.

INCOME		EXPENSES
Salary		Housing
Investments		Transportation
Other		Food
		Utilities
		Clothing
		Health/ Medical
		Recreation
		Other
TOTAL INCOME		TOTAL EXPENSES
		Total Expenses/Total Income= Debt Load

List some ways you can decrease your debt load

 

 

Quiz

1. Lenders review your income and expenses prior to approving your loan application.
True False

2. If you divide your monthly debt payments by your total monthly income, you will get your monthly debt/income ratio including housing cost.
True False

3. Using the 28/36 rule, your non-housing debt shouldn’t exceed 36% of your gross income.
True False

4. When determining your debt load limit you should consider the stability of your income.
True False

5. It is cheaper to save for an item first then to buy on credit.
True False

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