Affordability is an illusion. It is like a ticking time bomb even to those who keep their budget in check. It’s amazing how retailers, salespeople and even some bankers can seem to press random numbers rapidly on their calculators and spreadsheets, and then show you how to make this huge new purchase affordable through low, easy, monthly payments. Typically, this happens at a condominium open house.
The appeal of the “low, easy, monthly payments” is easy to fall for. Just because a bank will give you a loan and you can figure things out (i.e. shifting around your budgeting plans) to make the payments does NOT mean you can afford to make that purchase.
The loan that you take might just mean you are accumulating debt, which will snowball to a point that overwhelms you. It will be especially challenging when interest rates rise, when you lose your main source of income, or if some other emergency expenses pop up.
You need to look at what you can truly afford to live a comfortable, happy, kind of life that does not keep you awake at night wondering how to pay off your debts.
How To Check How Much You Can Afford
For a start, you can check your total debt-to-income ratio, which helps lenders assess their ability to cope with monthly payment and service debts. The ratio is calculated by adding up your monthly debt payments and obligations and then dividing them by your gross monthly income. Multiply by 100 to get a percentage figure.
Debt-to-income ratio (%) = [Total recurring monthly debt / Gross monthly income*] x 100
*Gross monthly income for employees refers to the gross monthly wages or salaries before deduction of employee CPF contributions and personal income tax. It comprises basic wages, overtime pay, commissions, tips, other allowances and one-twelfth of annual bonuses. (Source: Ministry of Manpower)
Rule Of Thumb
An individual’s debt-to-income ratio should not exceed 40%. A debt-to-income ratio range of 40% to 50% is a sign that you may be heading for financial challenges. One is generally considered to be overstretched with repayment when debt is at 60%.
Getting to financial freedom isn’t just about living below your means because the concept is simply too vague. Without a proper “stop-loss” limit, it is easy to overlook your impending financial doom when an eager salesman or so-called financial planner tells you that you can buy that new car, expensive wedding package, or fancy condominium.
It is important to first know what is your debt-to-income ratio, your long-term financial goals (e.g. early retirement), and whether your spending is aligned with these desires. Only then will you know what you can truly afford.