Chapter 6, Problem 1DTM

a

Summary Introduction

To determine: The debt payments-to-disposable income ratio.

Introduction:

Establishment of debit limit:A debit limit is the overall maximum credit one should get based on his ability to meet the repayment obligations. The recommended safe debt limit is considered to be 11 to 14 percent debt payment limits as percentage of disposable personal income, the length of time that high debt payment is also important to consider.

They are three recommended methods for you to determine the debt limit.

1. Continuous-debt method:under this method, it is evaluated if it is difficult to get out of debt completely every four years, if yes it shows you are heavily dependent on debt.
2. Debt payments-to-disposable income method: it uses the debt payment to disposable income ratio excluding mortgage loan, it focuses on the amount of monthly debt repayment.
3. Debt-to-income method: it is based on the ratio of debt to income a ratio of 36 percent or less is desirable.

Answer to Problem 1DTM

KJ’s debt payment to disposable income ratio is 21%. It is way above the desired ratio of 14%

Explanation of Solution

Debt payment to disposable income can be calculated by following formula

K has an outstanding student loan for which he pays $900 per month and auto loan repayment $300 hence total non-mortgage loan payment debt is $1,200 and his disposable income

	Amount $
Salary	9,000
Less: Federal tax	(1,800)
State tax	(500)
Medicare	(700)
Social security tax	(230)
Disposable income	5,770

  $\text{Debt}\text{payment}\text{to}\text{disposable}\text{income}\text{=}\frac{\text{Monthly}\text{non}\text{mortgage}\text{debt}}{\text{Monthly}\text{}\text{Disposable}\text{income}}$

  $=\frac{\$1,200}{\$5,770}=0.20797$ Or 21%

b

Summary Introduction

To determine: Whether K’s plan to go for an automobile loan to buy a motorcycle is feasible.

Introduction:

Establishment of debit limit:A debit limit is the overall maximum credit one should get based on his ability to meet the repayment obligations. The recommended safe debt limit is considered to be 11 to 14 percent debt payment limits as percentage of disposable personal income, the length of time that high debt payment is also important to consider.

They are three recommended methods for you to determine the debt limit.

1. Continuous-debt method: under this method, it is evaluated if it is difficult to get out of debt completely every four years, if yes it shows you are heavily dependent on debt.
2. Debt payments-to-disposable income method: it uses the debt payment to disposable income ratio excluding mortgage loan, it focuses on the amount of monthly debt repayment.
3. Debt-to-income method: it is based on the ratio of debt to income a ratio of 36 percent or less is desirable.

Answer to Problem 1DTM

KJ should not go for another loan, as his debt payment to disposable income is not good.

Explanation of Solution

Estimated funds available for debt repayment is expected to less than 14%. Because K’s ratio is 21%, he may face difficulty in repayment of additional debt as he has too low disposable income. It will also affect spending capacity and may affect liquidity position of an individual that is he may face difficulty in managing day to day expenses, thus.It is not advisable for him to go for one more debt, as he may face difficulty in repayment of one more loan.