Do you know what your debt ratio is? It is probably one of the most important financial ratios around and is one factor in determining your credit rating, the interest rates you pay, and directly effects how much discretionary money you have to spend.
Savings Ratio: Should be between 10% to 20%. The ratio of current period’s cash surplus to the current period’s income after taxes. The current savings rate for Americans is 4.5% of disposable income, it was 7.2% in 1992. For most Americans, saving 10% of their income is not possible.
Consumer Debt Ratio: Should not exceed 20%. This is the ratio of monthly consumer debt payments to monthly (after tax) income. Add credit card payments, auto loan payments, and department store account payments.
Housing Cost Ratio: Should not exceed 28% of gross income. Total of monthly mortgage payment (principal + interest), plus 1/12th of annual real estate taxes, plus 1/12th of the annual homeowners insurance premium, plus 1/12th of the annual association fees divided by the gross (before tax) monthly income.
Total Debt Ratio: Should not exceed 36% of gross income. Calculated by dividing total monthly loan payments by the gross (before taxes) monthly income.
Total Household Debt: According to the Federal Reserve, total household debt was 114.6% of disposable income in the 2nd quarter of this year. That is down from 116% the previous quarter and down from a high of 130% in 2007. Prior to 2002, Americans debt burden remained below after-tax income as far back as World War II when data was first collected.
So now what? I already know I am not saving enough but what can I do?
Increase your Income
- Concentrate first on your current job. Size up the opportunities for advancement in your current place of employment. A good place to start is the job postings. Are most of the jobs listed in areas you lack the qualifications for? If so, you may need to go back to school to acquire those skills or start looking elsewhere. This is where your networking skills can help you land a position before it is even posted so continue attending happy hour with colleagues and making your boss look good.
- Look for ways to increase your income leveraging the skills you already have. Do you have a hobby like photography that you could parlay into a part-time income?
- Be creative in looking for ways to make money. Check out Creative Ways to Make Money Online.
Lower Your Expenses
- Cutting discretionary spending is the quickest way to increase monthly cash flow. Itemize where you are spending your money and prioritize needs versus wants. Go for the easiest cuts first to gain success and then be sure to get family members to buy into the plan. A successful financial plan must start with clear goals, a realistic way to get there, and a way to monitor your progress. Use a free service like Mint.com to keep track of your finances.
- Lower your debt payments. Refinancing a mortgage should be at the top of your list as long as you plan on staying in your home for the next 5 years and can reduce your interest rate by at least 1.5%. To get the best rates you should have a FICO Score of 740 or higher. For every 20 point drop in your score expect to pay .5% more in fees. Take advantage of balance transfer offers from credit card companies to pay off higher interest cards. Be sure to destroy the old card and do not make purchases on the new card since you will most likely pay a much higher interest rate on purchases.
- Have junior pay for his own car insurance. As more families find children returning home after college, it makes sense that they should share in the household expenses.
- Be creative in looking for ways to save money. Use coupons, rent from RedBox, delay that trip to Europe.
How about you? Do you know what your debt ratio is or have advice about how to improve it?