Knowing Credit: Credit Applications [Part 4/6] Affordability calculation example

Welcome back! In our Knowing Credit: Credit Applications [Part 3/6] ...

Knowing Credit: Credit Applications
Welcome back! In our Knowing Credit: Credit Applications [Part 3/6] we learned how credit providers will review your application for credit.
We also learned the definition of ‘creditworthiness’, which is a measure of the possibility that you will default on paying back your loan.
In today’s lesson, we will talk about how a credit provider will calculate your affordability and look at examples of affordability calculations.

Definitions of the week: GROSS INCOME and NET INCOME
Gross income is your total income, before deductions. Gross income can come from different sources, such as a salary/wages, tips, share dividends, rent, sales commission and overtime payments.
Net income is the amount you have left over after deductions. These deductions include income tax or pay-as-you-earn (PAYE) tax, unemployment insurance fund (UIF) contributions, and possibly even pension fund and medical aid contributions.

The formula for calculating affordability is:
Income minus necessary expenses, minus all other payment commitments, equals discretionary income.
Knowing Credit: Credit Applications
What these terms mean?
  • Income: This is your net income.
  • Necessary expenses: These are expenses that you cannot live without, for example housing, transport, food, and electricity.
  • All other payment commitments: These include existing debt repayments, savings, and other fixed expenses.
  • Discretionary income: This is the ‘affordability amount’ – what you have left over after all deductions and expenses, which you can use to repay the credit you are applying for.
Let’s look at an affordability calculation example:
  • Susan is a teacher at a school.
  • She earns R15,000 a month.
  • The school deducts PAYE, UIF, and a pension contribution from her salary.
  • The school pays half of Susan’s medical aid (she pays the other half).
  • Susan is paying off the vehicle finance on her car, which is also insured.
  • She rents a flat.
  • Susan has a clothing account which she pays each month.
  • Susan spends about R1,000 a month on groceries.
  • She goes to dance lessons every week, which she pays monthly.
  • Susan would like to take out a personal loan for R10,000 to redecorate her flat.
Here’s what Susan’s affordability calculation would look like:
Knowing Credit: Credit ApplicationsSusan has R4,699 left after all her deductions and expenses. This is Susan’s discretionary amount. She has found a credit provider that offers the loan amount she is looking for. With the interest and a credit protection plan (this is like credit insurance, in case you lose your job), Susan’s total monthly repayment on the loan would be R1,174.

Her loan repayments each month would only take up a quarter (25%) of her discretionary amount. This means she still has money left over for emergencies and unplanned expenses. What do you think the credit provider’s decision about her affordability will be?

Helpful Hint:It’s best to keep your credit repayments per month under 30% of your total income. Susan is able to track her credit repayment history on My Credit Check’s website – so can you! Go to My Credit Check and sign up for monthly reports at a small fee.

Next week, we’ll take you through a checklist of all the things you should take note of before applying for credit.