An assessment about what we can realistically afford is still a critical element in deciding on making a purchase or taking out a loan.
Calculating affordability is done with a simple formula, sometimes called your repayment-to-income ratio: Income minus necessary expenses, minus all other payments, equals discretionary income.
Let’s break this down:
- Income refers to your net income after taxes.
- Necessary expenses are those that you cannot live without (food, electricity, housing, etc.).
- Other payments include fixed expenses, debt repayments and savings.
Only once your expenses have all been measured against your income can you get to your discretionary income or affordability amount. In addition, credit providers may also take things into account such as; number of dependents, employment history and your credit history. Collectively, these checks make up what is referred to as your affordability assessment.
In South Africa the National Credit Regulator, the organisation that monitors how credit providers operate, has stipulated through the National Credit Act that registered credit providers may only extend credit or offer loans based on your ability to pay the money back, or as the Act calls it ‘affordability’. That is where the affordability assessment comes in.
If it sounds like the National Credit Act has been amended to make it harder for South Africans to get credit, then you’re right, that is exactly the intent. It was done to stop over-indebtedness and reckless offers of credit, but most importantly, to stop us from spending money we don’t have on things we don’t need.
More importantly, doing an affordability assessment regularly is a great habit to get into, not only when you apply for credit, but also as a means to manage spending.
So, while most of us may never own and drive a Jaguar, by focusing on building a strong credit history, spending within your means and not caving in to peer pressure, you’ll be surprised by what you can actually afford.