Budgeting can seem like an inconvenience when it comes to managing your personal finances, but if you want to manage your money most efficiently and live with financial security, you need rules to follow. In life, we obey traffic rules when driving, follow social etiquette rules when interacting with people, and we’re all familiar with the rules that must be followed when participating in sports. These everyday life rules serve as a way for us to avoid chaos and they create order and safety for ourselves and others.
Just as in everyday life, your money rules are no different. Applying rules of thumb for managing money is to give yourself parameters on spending so you don’t go crazy and put yourself in precarious situations that you’ll have a difficult time recovering from. It also gives you a guide on saving as a way to feel safe and comfortable, instead of becoming anxious and depressed over your lack of money.
Here are general explanations of three standard rules you can follow to help budget your finances and keep yourself feeling abundant with money.
1. The 28/36 Debt Rule
Also known as DTI (debt-to-income ratio), this is the golden rule for mortgage lenders when deciding to give you a home loan. It’s also a great way to determine if you’re overspending on your living expenses. It’s the best method to follow, especially if you’re looking to buy, refinance, or maintain a home or property. Following this rule will positively affect your ability to get a mortgage loan and help keep your spending under control.
The 28/36 rule states that a household should spend no more than 28% of gross income on total housing expenses, and no more than 36% on all debt.
28% Housing: This rule consists of housing expenses known as PITI: monthly principal, interest, property taxes and insurance. It also includes any HOA or condo fees. Estimate your monthly mortgage and any monthly payments and determine if it’s at or below 28% of your gross income. For example, if your income is $5000.00, 28% of this would be $1400.00 total maximum for your housing expenses.
36% All Incurred Debt: This rule includes all recurring monthly debt compared to your gross household income. This includes PITI, HOA or condo fees, and also any credit card debt, car loans, student loans or personal loans. Again, taking the example of a $5000.00 gross monthly income, 36% is calculated at $1800 going to all your monthly debt expenses. Anything over this percentage, and you’re spending too much on debt.
2. The 20/4/10 Car Loan Rule
Overspending on a car loan is common, especially with all the confusion presented around buying a car, the fees and expenses and any other unknown costs that go into this needed luxury. This 20/4/10 rule helps clarify your spending parameters on getting a car loan.
The rule is the best way to protect yourself from overspending on a car. This means putting 20% down payment on a vehicle, limiting your loan life to four years, and spending no more than 10% of your gross income. Each of these numbers has a reason behind them.
20% Down Payment: This may seem like a lot, but a more substantial down payment will keep you from owing more than your car is worth. Typically, when you drive the car off the lot, your car’s worth can plummet. Having something that’s worth more than what you owe on it is a primary key to staying above water with debt.
4 Year Loan: To keep your loan under 4 years will minimize the amount of interest you pay over the lifetime of your loan. This especially helps if you have to pay a higher interest for your car loan.
10% Loan Payments: Keeping your car loan payments under 10% of your gross monthly income will help keep you within your budget parameters.
Another good rule of thumb for buying a car: Buy used and drive it for 10 years.
3. The 50/20/30 Spending and Saving Rule
This general rule of thumb is the best way to keep you on track with your savings, managing your debt, and giving yourself some free personal spending.
50%- Essentials: This rule applies to your living expenses and essentials. This includes rent or mortgage, minimum debt payments, utilities, groceries, clothing, and transportation. Any costs that contribute to your daily needs will go under this category. The rule is to keep your expenses at or under 50% of your take-home pay.
20%-Savings: This rule applies to any and all financial goals. This consists of savings and investments but also includes any debt reduction, such as additionally paying down your credit cards or student loans to become debt-free. The goal, of course, is to have zero debt, so the entire 20% is going towards savings, investment, and retirement. Balance your 20% to your comfort level to achieve your financial goals.
30%-Personal: This rule applies to your personal spending budget. This is money towards nonessentials but enhances your lifestyle. It is the most flexible part of your spending and can give you some wiggle room to determine if you really want certain things in your life. This would be things such as entertainment, travel, pets, gym memberships, dining out, hobbies, or any other lifestyle choices and non-necessities. This also includes any maintenance spending for your non-essentials such as insurance or slip fees for your sailboat, as an example. 30% of your take-home pay is your maximum, and the less you spend in this area, the more you can contribute to debt reduction and a financial savings cushion for yourself.
This rule is a general guideline, especially if you’re new to budgeting and need a parameter to follow. It’s an excellent start to breaking down your spending and saving and can get you quickly on track with your budget.
Budgeting is a mindset. If you give yourself parameters to follow and stick within your guidelines, you’ll see a significant improvement in your spending and saving habits, and will be on your way to your financial goals. Start with these rules and adjust them as you need to and are able. Within time, you’ll find yourself on the right track to becoming the master of your money!
This piece was written by Michelle Birge. Michelle is a blogger on Medium.com. She writes on self-improvement and inspires people towards living a passionate life. You can find her blog here, or email her at firstname.lastname@example.org.