![]() ![]() Where I find this budget strategy most useful is in helping people make big financial decisions by creating a hypothetical budget for their future. One of my favorite budgeting methods is the 50/30/20 budget, which states that you should spend 50% of your income on needs, 30% on wants, and 20% on savings. The mortgage industry’s guidelines, on the other hand, are optimized to maximize their profits. Not only will you have a lower monthly payment but also 15 fewer years of making payments. With a lower mortgage payment, the idea is you’ll be able to avoid credit card debt and invest more over time. The big takeaway here is that Ramsey’s guidelines are optimized to help you build wealth. The Personal Finance Ratios You Need to Know Loaning you as much money as possible maximizes the bank’s bottom line, not your finances. In other words, this is the largest amount of debt banks have found you can take on and still have a reasonable chance of paying back. For lenders, the purpose of the 28/36 rule is to determine the largest amount of debt a person can have. It’s important to look at this ratio from both a lender’s perspective and a consumer’s perspective. Then, total loan payments (housing plus all other debt) should not exceed 36% of your gross income. The rule states that you shouldn’t spend more than 28% of your monthly gross income on housing (this includes principal, interest, taxes, and insurance). Instead, it’s the rule mortgage lenders use to determine your home loan. The first thing you need to know about the 28/36 rule is that it’s not a rule used in financial planning. Taking a closer look at this ratio, I recently wrote: What this says is that your total monthly debt payments should not exceed 36% of your pre-tax income, with a maximum of 28% going towards housing. The standard debt-to-income ratio used in the mortgage industry is called the 28/36 rule. Why such a difference? To understand that, it’s important to understand the guidelines used by mortgage providers. Yet shows a mortgage payment that’s $579 higher than what Ramsey suggests. Ramsey, on the other hand, suggests a 15-year fixed-rate mortgage. Keep in mind, is showing you what you can afford on a 30-year fixed-rate mortgage. Perhaps unsurprisingly, ’s calculator suggests you can afford to buy more house than Ramsey’s. Ramsey’s affordability calculator also gives you an estimate of how much house you can afford based on your monthly take-home pay: How Much House Can You Responsibly Afford?ĭave Ramsey’s rule allows you to buy much less house than most mortgage lenders and real estate agents want to sell you - not to mention, much less house than other calculators will say you can afford. To get this number, simply look at your recent paychecks. Gross income is the amount you make before taxes and other deductions, while net income is the amount you make after taxes and other expenses are taken out. Ramsey advises using your monthly take-home pay (also known as net income or after-tax monthly income) rather than your gross monthly income. To find out your monthly maximum mortgage payment, just take your monthly-after-tax income and divide it by four. Therefore, you hardly need to use the calculator to follow this rule. Luckily, you can use resources like the calculator below to figure out how much green goes in each of your buckets.Ramsey has the simplest affordability calculator you’ll find.Īccording to Ramsey, your monthly housing expenses should never be higher than 25% of your monthly after-tax income. So, if you take home $5,000 a month after taxes, you can afford a $1,250 total monthly housing payment. Ultimately, you need to decide what type of budgeting system is right for you based on your habits and circumstances. For example, when you've paid off your student loans, you can allocate more of your monthly budget for savings. You may be able to meet those numbers in the future. If you try the 50/30/20 budget method and don't hit the percentages exactly, be kind to yourself. Or you might find the lack of detail makes it harder for you to improve your spending habits. You might find it easier to track the three categories rather than categorizing each individual expense. The categories also may or may not work for you. So, you may need to adjust the percentages to fit your situation. For example, if you live in a high-cost area, you may have to put a large part of your income toward housing, making it difficult to keep your needs under 50%. Depending on your income and where you live, earmarking 50% of your income for your needs may not be enough. The 50/30/20 rule can be a good budgeting method for some, but it may not work for your unique monthly expenses. ![]()
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