What is a Personal Finance Ratio and Why Should You Care?

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Do you really know if you are financially healthy?

Look, even though you may have a pretty decent budget, better spending habits, or even a really solid plan to pay down your debt, you still need to know your personal finance ratios.

What are they exactly? Well, financial ratios are really important in determining aspects of your personal finance, like your credit rating all the way to how much money you can actually spend.

Think about it as a way to not only identify your net worth but a way to track the weaknesses in your finances. That way, once you’re armed with all that knowledge, you can take measures to make sure you and your family are secure.

Not sure where to start? Don’t worry, just make sure you calculate the five personal finance ratios.

Consumer Debt Ratio

This is how much monthly consumer debt payments you have divided by your after-tax income every month. To figure this ratio out, add up all your monthly debt repayments, which could be a credit card, mortgage, car loans and even payments to family and friends.

The consumer debt ratio is a way that lenders determine how well you can manage your monthly payments so you can repay what you’ve borrowed. The higher it is, the least likely lenders will see your favorably. Late payments on your credit report are damaging and can hinder lenders from approving you for additional financing options in the future.

Savings Ratio

This is basically how much cash you have left over from your post-tax income every month, after deducting all your spending. Ideally, you want this ratio to be anywhere from 10% – 20%, more if you can do it. Obviously, the higher the savings ratio, the more financially healthy you are.

Housing Cost Ratio

This is to help you determine if you’re paying too much for your house. To calculate this ratio, take your monthly mortgage payment (principal and interest), 1/12th of your annual homeowner’s insurance premium, 1/12th of any annual association fees, and 1/12th of your annual real estate taxes and divided it by your gross (pre-tax) income.

If this ratio is greater than 28%, you may be paying too much for where you live.

Total Household Debt

This ratio helps you determine how much overall debt you have in your family. It’s pretty to calculate this one: simply add up all debt (consumer, mortgage and any other kinds of loans) and divide it by the household’s total monthly income post-tax. Again, the higher this ratio is, the worse off you are.

Total Debt Ratio

This is the ratio by how many assets you have versus how much you owe. It’s slightly different than the total household debt in that this one is measuring individuals. For this one, all you have to do is take your total monthly loan payments and divide it by all monthly income (include assets such as investments too if you can).

If it’s higher than 36%, you need to take a more careful look at your finances. You could consider something like making more money to bring that ratio down.

Figuring out these ratios is the first step in assessing and bettering your financial health. Getting these numbers is a great start because then you can carve out a plan of attack moving forward.

2 thoughts on “What is a Personal Finance Ratio and Why Should You Care?

  1. Pingback: How to Improve Your Starting Credit Score | Stapler Confessions

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