It's funny how some things come to us automatically. When you go to pay your bill at a restaurant, you add in 15% for tip, or when you're invited to a wedding, $50 - $100 is inserted into the card for the bride and groom.
Our culture has engrained these numbers into our mind and therefore, we adjust our lifestyles, budgets, etc. to account for them.
Here are some numbers that also should be remembered as they can have a profound affect on your financial life:
30% of gross income
When purchasing a home, your total cost (including property tax, insurance, and maintenance fees) should not exceed this number. I know in a previous column I used 1/3 which is technically 33% but 30% is really what you should be shooting for.
Lenders will be able to qualify you for much more than this (up to 55% of your total income), but that doesn't mean you have to spend that much on a house. In fact, I would consider having a house payment that's 45% or more of a person's gross income foolish.
30% will give you the flexibility to save for other things like retirement and college which we'll get to in a minute.
10% of purchase price
The bare MINIMUM you should be putting as a down payment on a home. I understand that we live in the state with one of, if not THE highest cost of housing in the nation, but that doesn't mean being crazy and applying for a no-money down, high interest, gotcha loan.
Even with the 10% down you will be subject to mortgage insurance which cost rises as you borrow more money. This extra payment will stick with you until a) you pay enough into the property so that your equity grows to 80% or b) the property's value rises enough so that you have 80% equity. Option b is somewhat unlikely right now and seeing as how you're paying almost 100% interest the first few years of your mortgage, that extra 10% is going to take a while to accumulate.
Preferably, 20% would be better.
8% of gross monthly income
According to Vern Farnsworth, director of public policy for the National Foundation for Debt Management this is the "high" amount you should use for recurring debt (credit cards, car payments, student loans).
Optimally, this number should be zero, but if you have to go into debt, do not exceed this number. To calculate, add your debts and divide by your monthly gross income. If your number is higher than eight percent, it's time to do some budgeting and rein in that debt.
If you don't have any debt, that's awesome! There are some great things to do with that money.
1/3 of the cost
Amount you should save for college. Do this early, and you'll be set. Example:
If you feel as though you'll want to send your child to a college whose tuition is $15,000 a year (add $10,000 for room and board).
$25,000 X 4 years = $100,000
Therefore, you need $33,000. If you start right when the child is born you have 18 years so $33,000/18 = $1,834/year = $153/mo.
Putting $1,834 into an Educational Savings Account (ESA) or 529c Plan which both allow your money to grow TAX FREE will give you roughly $100,000 by the time junior is college bound.
Starting later? No problem. If you don’t have the time to let the money grow with interest the first third is taken care of, the second third can be paid for through current income and the final third can either: my choice = be paid for by junior through a job while going to school or secondary choice = student loans.
Too many people put off saving for retirement and save for college which is backward.
15%
The amount you should be putting toward retirement.
This money should be spread out through good, growth stock mutual funds with long term track records of performance. Over the long term, the stock market has averaged an 11% return. Because this is retirement you should not worry about ups and downs like we are seeing right now.
The 15% can first be directed into any retirement account where some else matches up to the match (ex. 401K). From there, fully fund a ROTH IRA which grows tax deferred. Anything after that can be placed either back into your 401K or other investments.
25 times your current income
The amount of money you'll need in savings to retire today and continue your current lifestyle.
If you make $50,000 a year then you need $1,250,000 in assets.
By taking out 4% a year ($50,000) you would not dig into your nest egg and still have the same type of lifestyle. Of course, when the market is doing better, it will allow you to grow your nest egg as inflation will go up over time.
Of course, this column is not a substitute for professional advice and you should seek counsel from your financial professional before making any major decisions.
