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The 8 Percentages You Should Live Your Life By

Life is hard right now. Some people are without jobs, some have lost their houses and most people have lost money in investments and the value of real estate. With the country being in debt to itself and foreign nations, and its people borrowing money like there is no tomorrow, it’s hard to know how much is too much.

How much debt is too much?

Can you afford to buy that new car? House? Rental Property?

Are you saving? Are you investing enough?

Below I’ve outlined some “rules of thumb” that you should be living your life by. If you’re not, then try to shift your behavior into meeting the guidelines. The views below might not be popular or easy, but they are a necessity to making sure you don’t end up in financial trouble.

Consumer debt should not exceed 20% of your monthly take home (net) pay. If you are already above that limit, cut your budget to the bones and pay that debt down/off. Consumer debt (credit cards being the leader in this area) has a strange habit of sucking the life out of you and it’s not until you’re “debt free” that you’ll realize this. Pay off all of your consumer debt and feel the difference – if you don’t feel relieved / ecstatic / free that you don’t owe anyone anything, just go out and get more debt.

Mortgage debt should not exceed 28% of your gross monthly pay.

If you have an ARM (Adjustable Rate Mortgage), this could get you in trouble quicker than you think. Picture the scenario – you can easily afford your mortgage when you get it, you / your spouse loses their job, your rate adjusts, and suddenly your payment is now 55% of your take home pay. How to avoid this? There’s no fail-safe to avoid this, but aim to get a fixed-rate mortgage on a 15-year mortgage and have it fall under the 28% guideline.

Your total debt payments should not exceed 36% of your gross monthly pay.

If you find that it is, make it your primary goal to get below this limit. The reason that 36% is considered too much is that you then won’t have any extra cash to save up for purchases, invest into retirement accounts, pay for necessary expenses, etc. However, remember that these percentages are “rules of thumb” and you situation is unique.

Always put at least 20% down on a real estate transaction. If you can’t, you can’t afford the house you’re about to buy. You know that part of the American dream where you can only be happy and fulfilled if you own your own home? That’s a lie. If you own your home instead of renting, but you can’t afford to eat or pay the light bill, then the American dream just became a nightmare. With over 20% down, you’ll avoid PMI (Private Mortgage Insurance), which is like an insurance premium that you pay to ensure your mortgage lender against a loss if you should default on the loan. When you put over 20% down on a property, you become more invested (financially and emotionally) in the property and less likely to walk away.

Rental real estate – aim to have 50% equity and a large cash cushion (1 year of mortgage payments). Want a quick lesson in how a foreclosure works? Buy a rental property with $0 down, hope your tenant will pay you every month and don’t have any cash reserves. They don’t pay, you have no cash, and then the bank forecloses on you. This situation is like walking on the edge of the cliff – you’ll stress that everything will work out and when it doesn’t, your life will start to unravel around you. A rental property should be an investment that doesn’t keep you awake at night, and if it does, maybe it’s time you sell it.

Vehicles – the value of your cars/bikes/boats should not exceed 50% of your annual income and you should aim to pay cash for all of them. Speak to an investment professional and outline this investment. “I’m going to finance an asset, put 25% down, pay off my investment over 4 years, and it will be guaranteed to lose at least 40% in that time.” They’ll look at you as if you’re crazy. That’s what you do when you finance vehicles – barely any vehicles go up in value (only collectibles do), so buy a reliable car and drive it for as long as you can. If you have to finance it, pay it off within a year.

(Aim to) Invest 15% of your take home pay into retirement accounts. These days not many of us will retire with a pension to cover all of our financial needs. So we’ll need some other funds that will support us. Most, if not all, of you will be familiar with 401k’s and IRAs but are you saving enough into them? If you don’t know and don’t want to do a retirement income projection, then aim to do 15% of your net pay. This will be a tough goal if you’re not used to it. If 15% is too big of a goal to start with, then aim for 10%, and then increase it by 1% every 6 months.

The most important: Tithe (or donate to charity) 10% of your take home pay. Money plays weird tricks on people. “The more you have, the more you’ll fear losing it”. Do something awesome with your money, and instead of buying something else for yourself, ask a local charity what you could buy to help them. The joy you’ll feel from helping someone out with your money with be far and above the feeling you’ll get from obtaining your new possession.

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May 12th, 2009 | Category: Personal Finance | 1 Comment »
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