You have seen that consumers' demand is affected by their level of income. Current income can, however, be supplemented by the use of credit (borrowing). Often, the availability of credit makes it easy for people to spend more
than they really can afford. You need to be careful about how much you borrow. How much credit can you afford? As a rule of thumb, the amount of credit
payments you make each month should be less than 20 percent of your take-home pay. Thus, if you have take-home pay of $1,500, you should not have more than $300 a month in credit payments ($1,500 x 0.2 = $300). This amount does not include housing.
A family has an after-tax (take-home) income of $3,600 per month after paying for their housing. Currently, the family's monthly payment on their
Sear's charge is $122. They also have a VISA payment of $110 per month. Last week, they decided to replace the family car with a new minivan. Assuming that they have no other credit payments, how large a monthly car payment can
they afford?
The family's take-home pay is $3,600 per month. According to the rule of thumb, their total credit payments each month should not exceed 20 percent of their take-home pay, or $720.
Currently, their monthly payments on their Sear's charge and VISA are $122 and $110, respectively, for a total of $232 in credit payments. Subtract this from the maximum allowable credit payments of $720 to find that they can afford an additional $488 in credit payments each month.
Therefore, the maximum monthly car payment they can afford is $488.
To determine how large a monthly car payment the family can afford, we first need to calculate 20% of their take-home pay.
Take-home pay after paying for housing = $3,600
Maximum monthly credit payments (excluding housing) = 20% of $3,600 = $720
Currently, the family has monthly credit payments of $122 (Sear's charge) + $110 (VISA) = $232
To find the additional car payment they can afford, subtract their existing credit payments from the maximum allowable credit payments:
Maximum monthly car payment = Maximum monthly credit payments - Current credit payments
Maximum monthly car payment = $720 - $232
Maximum monthly car payment = $488
Therefore, the family can afford a monthly car payment of up to $488.