Disposable Income: Everything You Need to Know
Disposable income, or disposable personal income (DPI), is the gross amount of money that people or companies have exceeding what must be paid for income taxes.4 min read
What Is Disposable Income?
Disposable income, or disposable personal income (DPI), is the gross amount of money that people or companies have exceeding what must be paid for income taxes. In order to calculate the amount of disposable income you have, you can subtract your income taxes from your total income. However, after you receive your DPI, you’ll want to calculate your discretionary income, which is the money you have left after you subtract all necessary expenses from your DPI. Necessary expenses include mortgage payments, insurance costs, groceries, transportation, loans, etc.
Important Facts Regarding Disposable and Discretionary Income
- Both types of income are used to measure the amount of consumer spending.
- Both incomes are key economic factors used to measure the level of wealth of the economy overall.
- Necessary expenses can include bills such as phone, cable, car, rent, mortgage, furniture, groceries, loans, and other required expenses. You won’t want to include money spent on dinners, haircuts, or clothing; these items are purchased with your discretionary income. Therefore, subtract only those required expenses that you must pay back.
- The disposable income will always be greater than your discretionary income since disposable income is simply the amount after you’ve subtracted your income taxes.
- Disposable income is used to gauge not only the level of consumer spending but also the level of consumer savings. Therefore, the personal savings rate may be higher, in which people put the funds directly into a retirement account or wait to use the money at a later date.
- Economists can also gauge the propensity of consumers to spend by analyzing any increase in disposable income with that of consumer spending. Therefore, for some, if their disposable income is higher, their spending may also be higher. But this wholly depends on one’s discretionary income, which must be calculated after identifying the amount of disposable income one has.
DPI Wage Garnishment
The federal government uses another approach to determine one’s disposable income for wage garnishment. Sometimes, a taxpayer’s wages may be garnished for a number of reasons, including taxes owed, alimony, or child support. The person’s disposable income will be the starting point in determining how much money to seize from the person’s paycheck. More specifically, in 2016, the amount that could be garnished from someone’s pay could not be greater than 25% of his or her disposable income or an amount that is greater than 30 times the federal minimum wage, whichever number is less. Moreover, the federal government will subtract health insurance payments and automatic retirement plan payments before calculating disposable income for garnishment intentions.
Household Net Disposable Income
Household net disposable income is calculated by taking the sum of household income, wages, and other earned money and subtracting all income taxes paid. To break this down, you will add up your household wages, salaries, any other income, net property income (if applicable), and any net transfers in kind (net amount). Net property income means any property income you receive, i.e. if you own a home and rent it out. Net transfers in kind could be a simple transfer from investments. After adding the previously mentioned numbers, you’ll then subtract out income taxes. The number you get will be your household net disposable income.
Applying for a Mortgage: Which Type of Income Should I Use?
The debt-to-income ratio is the most critical one regarding disposable income when seeking a mortgage. This number tells lenders how dependable you will be when it comes to making monthly payments. The lower your ratio, the better, and the better chance you will have of obtaining a loan. However, a high ratio indicates that you don’t have as much disposable income and are unable to take on additional debt, making it much harder to obtain a loan. Even if you are able to put 20 percent down on your home, this doesn’t necessarily mean that you will be qualified for a mortgage loan for the amount you are seeking. While you have a better chance of obtaining a loan since you put a higher percentage down, your high debt-to-income ratio means that, over time, you will be a greater risk for the lender when it comes time to make your monthly payments. Moreover, lenders understand that when people buy homes, they generally make additional improvements to the home, which can include a new roof, new appliances, new furniture, new flooring, etc. Any money that could potentially be spent on additional luxury items will be a major factor in approving you for a loan.
Therefore, while you are applying for a mortgage, the last thing you want to do is open another credit card or buy a new car. This will likely reduce any chances you have of obtaining a loan, unless you have an extraordinary amount of disposable income above and beyond the price of the home itself. We have all heard the saying “I’ve become house poor,” which means that you put almost all of your savings into the down payment for the home. This holds true for most people who purchase a home and subsequently make improvements to the home immediately thereafter. That’s why it’s so important to understand your disposable income, discretionary income, and your debt-to-income ratio so that you have a better idea of what you can and can’t afford, particularly when it comes to purchasing big-ticket items.
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