Personal Financial Ratios Everyone Should Know


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.

personal financial ratios

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 haveDo you have a hobby like photography that you could parlay into a part-time income?

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?

 

 

 

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28 Responses to Personal Financial Ratios Everyone Should Know

  1. SB @ One Cent At A Time 10/20/2011 at 3:52 am #

    I am doing good on all the ratios, except I am not a home owner yet. The housing is bit costlier here in south Florida. Need to increase my passive income a bit more before I buy home to be well within the ratio you suggested.

    • Paul 10/20/2011 at 4:06 am #

      Luckily my wife is not a Teacher so we are doing ok. We used to live in Orlando SB, fun place to live but the summer’s were a little humid. :)

    • KYD 05/22/2012 at 4:19 am #

      Liked all the ratios you have mentioned above.

  2. Shaun @ Smart Family Finance 10/20/2011 at 4:20 am #

    This is great!

    I’d add net worth to your list. It’s not a ratio, but it’s just as useful.

    • Paul 10/20/2011 at 5:40 am #

      I have an article planned on that one and decided to leave it off the list. Thanks for stopping by Shaun.

  3. Wealth Management 10/20/2011 at 8:16 am #

    I think this is a great goal to shoot for, but many people just have way too many expenses in which they’re responsible. It would take a lot of hard work for many people to get close to these ratios. Most are happy with whatever free time and disposable income they have now. It’s unfortunate, but it’s true.

  4. Jeff @ Sustainable life blog 10/20/2011 at 9:42 am #

    Great post – I love simple ratios like this. They are simple and easy to track. While they may not worwork for everyone in every situation, they are great rules of thumb.

  5. Neo 10/20/2011 at 6:04 pm #

    There is another ratio that I find very useful: Liabilities-to-Net Worth Ratio. This ratio really helps me to understand if all the adjustments I make to my spending, budget, borrowing and portfolio decisions are really working. Here is an article about it:

    http://networthprotect.com/2011/07/19/how-to-calculate-your-personal-net-worth-and-why-you-should/

    • Paul 10/20/2011 at 6:52 pm #

      Thanks for sharing that important ratio. I tried to gear this article to the average consumer and keep the focus narrow. I agree with you that liabilities to net worth is an important ratio. That ratio is typically higher with lower incomes than higher incomes but not always. It is a great measure as to how leveraged you are and if you are living withing your means.

    • maria@moneyprinciple 05/21/2012 at 9:01 am #

      Hi Neo, glad to see you are back.

  6. PKamp3 10/21/2011 at 5:32 am #

    “Have junior pay for his own car insurance.” – I like that. Make him pay for his gas too, haha. When I drove my father’s car he’d insist on gas money. Looking back, I’m sure I’ll do the same thing.

    • Paul 10/21/2011 at 7:39 am #

      I think it can help to build some important skills if you teach your children how to be responsible for their own lifestyle decisions. It can be something as small as buying their own movie ticket to paying part of their college tuition. The key is to start as young as possible. We pay for our 12 year old’s cell phone bill however she lost her phone not once but twice. The first one we covered but she had to cover the second replacement out of her savings account. Luckily we have insurance and she only had to pay $40.

  7. Doctor Stock 10/24/2011 at 6:56 pm #

    Some great tips on a fairly fundamental topic. Now if only you could advise the government officials.

  8. Monica 02/14/2012 at 10:30 am #

    Hi Paul
    We are trying to instill in our boys the importance of financial responsibility and saving, so that they can hopefully avoid debt. Many of the kids they go to school with are quite privileged and have new cars, but we have an old beater that we keep around for our teenagers to drive. It’s a 10 year old Jeep Grand Cherokee, but it looks good and runs great. We own the car and pay the insurance, but since they are allowed to drive it, they are responsible for the gas. Both of our sons work part time jobs to pay for their own things, outside of food, school clothes, etc. They also have to do chores around the house and don’t get paid an allowance. We might sound mean, but I see too many spoiled kids that have no clue about real life finances and I don’t want our kids to be like that!

    • Paul 02/14/2012 at 11:11 pm #

      Sounds like you are doing the right things to teach your children how to manage their finances and appreciate the value of a dollar. Those are skills that they will use the rest of their lives.

    • Michael 03/06/2012 at 10:01 am #

      You’re not being mean at all! You’re instilling great values in your sons to teach them that money doesn’t grow on trees. I’m 26, my parents made me drive a 1984 Volvo to high school when most of my friends were spoiled rich kids with new cars, so I can empathize with your sons a bit :)

      I’m now a mechanical engineer with a good-paying job and can enjoy nice things, but still live within my means.

      Keep it up!

  9. Jeff 03/05/2012 at 2:42 pm #

    10% savings ratio? That seems…very high. Does that include college savings and retirement savings? Or is this oriented toward “You’re going to have to put a downpayment on a car, replace a roof, and save just in case you lose your job” money?

    Definitions are always crucial to this sort of advice. But thank you for clarifying some other ones. I’ve been looking for a good house ratio definition for a while; does 28% mean before or after taxes, before or after 401(k)’s? Thanks for answering that.

  10. maria@moneyprinciple 05/21/2012 at 9:05 am #

    All my ratios seem to be in line – time to stop worrying, it seems. And I think that the different ways to approach the situation if the ratios are out are specific to to time on the ‘progress line’. What I mean is that the debt ratio is high to stabilise the situation one ought to look at discretionary expenses (followed by other expenses). Once stabilised one ought to turn to increasing income.

  11. Untemplater 05/22/2012 at 9:12 am #

    Very helpful ratios to know. And wow that chart is so depressing to look at! But it’s a wake up call a lot of people need. Getting control of debt is so important!

    • Paul 05/22/2012 at 12:21 pm #

      Hi Sydney! When I first saw that graph I knew why we were in the midst of a financial meltdown. Americans were financing a lifestyle on debt!

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