To find out whether you can afford to repay a loan, take the difference between your income and your expenses. This is your discretionary income. From this amount, you’ll need to first deduct your minimum monthly savings. It’s a good idea to also deduct additional savings to help you meet some of your financial goals. These might include buying a house or a new car or building an emergency fund.
What’s left over defines how much new credit you can afford to take on. If you’re only just meeting your monthly bills, an unexpected expense could mean a serious financial setback.
If you are already paying off debt, which should be included in your expense summary, you may not be in a position to use additional credit until your existing obligations are repaid.
Some argue that any debt is too much. Others say that you should have only good debt (for investing) and no bad debt (for spending). In reality though, debt is simply a financial tool that you should use wisely to avoid getting in over your head.
There are several measures you can use to determine whether you’re carrying too much debt. One we rely on is known as the total debt service(TDS) ratio. As a general guideline, no more than 40% of your monthly gross (before deduction/taxes) income should go toward mortgage loan payments and other monthly debt obligations.
Realistically, the amount of credit you can afford depends on your personal situation. If your current employment is not secure, you will probably want to take on less credit than the recommended guidelines. On the other hand, if you have no other obligations, such as a mortgage, and your source of income is reliable, you may want to take on more credit, depending on your goals.