Is your mortgage or rent payment too high for your income?
Is
your car payment too high for your income? What can you
really
afford to spend on gift giving each year? Good questions.
How do you know what you really can and cannot afford?
This
article will explain how to use some basic guidelines to answer these
questions. Why is this article only talking about
mortgage/rent, car payments and gift giving? Because these
are the areas of a family budget where the most overspending commonly
occurs causing
financial stress and keeping people from getting ahead with their
finances. To figure out what your guidelines should be for all
areas of spending, read the article You
Need a Plan.
When I say 'guidelines' I'm talking about a concept called
'Percentage
Guidelines.' It sounds impressive, but all it really means is
the
percentage of your income that you can afford to spend on the
expenses I mentioned above. The Percentage Guidelines I'm
about
to give you are based upon your average take-home pay. I'm
not
talking about your gross pay; I'm talking about how much is left after
your employer makes all of the deductions from your pay for such things
as FICA, income tax, dues, insurance and so forth.
I
explain how to calculate your monthly take-home pay in the article You Need a Plan.
How much mortgage or rent
payment can you afford?
First of all, understand that I am not talking about how much
mortgage
payment you can manage to pay. If you don't mind spending the
rest of your life broke and financially stressed, then you can possibly
manage to make a much larger mortgage payment than I am telling you
here. The mortgage payment I am figuring out here is one that
is
reasonable, do-able and can be done pretty much stress-free.
The
mortgage payment I'm calculating here is one that should allow you
enough room in your budget to get out of debt, save up some money and
start working toward becoming wealthy. You may not have as
big a house as you want, but you'll have one that you can afford.
If you are trying to get out of debt and become wealthy, then
you can
afford a mortgage payment of around 20% of your monthly take-home pay.
To figure this out, just
multiply your monthly-take-home pay by .20
(point two zero). Here is an example:
Monthly take-home pay is $2,800 so 2,800 X .20 =
$560 per month.
This amount may seem awfully low to you, but it is possible
to have a
mortgage payment this low if you buy a smaller house, or a house in a
different neighborhood, or save up a larger down payment.
Could
you make a larger payment than this? Probably--but not if you
are
trying to become debt free and wealthy. Now please realize
that
20% of take-home pay is just the 'ideal' amount for a mortgage
payment. You can usually go as high as 25% and still be okay,
although it will take you a bit longer to get out of debt and become
wealthy. This upper amount is calculated by multiplying your
monthly take-home pay by .25
(point two five). For our previous example, this new amount
would be:
$2,800 X .25 = $700 per month
Quite a bit more, but remember that it will be more difficult
to save,
get out of debt, and become wealthy with this higher amount.
Still possible, but it will require more time and a bit more
financial stress in your life. Whatever you do, though, don't
take on a mortgage payment more than 25% of your take-home
pay. Also, keep in mind that lending institutions
(banks, credit unions, etc.) will often qualify you for a much higher
payment than 20%, and that being qualified for a larger payment doesn't
mean you can afford it--especially if you are trying to eliminate
financial stress from your life. For more information about
getting a mortgage, be sure to read
the article What Kind
of Mortgage to Get.
What about rent?
To do a calculation to figure out how much rent
you can afford,
do the same calculation we just did using the 25% guideline.
The
reason you can afford more rent than you can mortgage is because owning
a house also requires taxes, additional insurance, and maintenance.
When you rent, the landlord generally takes care of these
things.
How much car payment can you
afford?
First of all, I recommend having no car payment--ever!
It is very
possible to drive nice cars and have no car payment. I have
done
it and so have many, many others. To find out how, read my
article How to Never Have a Car
Payment Again.
But, if you insist on having monthly car payments, the
guideline is to pay no more than 6% of your monthly take-home pay in car payments. To figure this
out, you
multiply your take-home pay by .06
(point zero six). You need to understand that this amount
represents what you can afford for all
of your car payments combined!
So, if there is more than one car payment coming out of your
take-home pay each month, then this 6% needs to cover all of those car
payments added together. In our example, the
total for all car payments combined is:
$2,800 X .06
= $168 per month in car payments.
Yes, I know this doesn't seem like much, but it is a lot when
you
consider that you can have no payments at all after you read the
article I referred to above. If you need to get your car
payments
down, you can buy a less fancy car, buy an older car, or save up a
larger down payment. If your total car payments are much more
than this 6% guideline, those payments are likely to be a source of financial stress
in your life and are going to make it much more difficult to get
ahead, get out of debt, and become wealthy. Remember, that I
recommend having no car payments at all, but if you insist upon it then
do not spend more than 6% of your take-home pay on car payments.
Gift
Giving
Keep in mind that gift giving includes all of your gift
giving
including Christmas, Holiday, birthdays, graduations, anniversary,
special occasion, etc. Gift giving is an area of spending
where
most people have a great deal of trouble. Overspending in
gift
giving keeps a lot of people in financial stress. The
guideline
for gift giving for the entire year is 1.5%
(one point five percent) of your annual take-home pay. Take
your
monthly take-home pay amount, multiply it by twelve to get your annual
take-home pay amount, then multiply that by .015 (point zero one
five). In our example that would be:
$2,800 X 12 = $33,600 annual take-home pay.
$33,600 X .015
= $504 to spend on gift giving for the entire year.
Again, this doesn't seem like much, but gifts don't have to
be
expensive store-bought gifts. You could buy less expensive
gifts
(it really is the thought that should
count); or give homemade gifts; or give gifts of your time for such
things as free babysitting, pet sitting, house cleaning, car washing,
etc. You could continue to be extravagant in your gift giving
and
overspend, but
it is really difficult to do that and
become debt free and wealthy.
Conclusion
Limiting
your spending in the areas of mortgage / rent, car payments and gift
giving is critical to eliminating financial stress and to having the
extra money needed to eventually become wealthy. If you don't
have control of these three areas of your budget, it will be nearly
impossible for you to have control of the rest of your spending.
And don't forget that, although you may be settling for less house,
less car, and cheaper gifts now, once you are debt free and wealthy,
you will be able to move up to a bigger house, a nicer car, and more
extravagant gifts.
To
learn a lot more about saving, investing,
eliminating debt and
becoming wealthy, please read the articles
on the Financial Page.
There, you will find a veritable treasure of what to do and
how to do
it.