It Pays to Do the Math In the Budget Game
By Michelle Singletary
Most people can tell you pretty much to the penny how much their mortgage or rent is every month. They can tell you how much they pay each month for their car loan.
But ask them what percentage of their income should be allocated for housing or transportation and they hesitate.
Many don't know.
"Most consumers we counsel don't know how to create a realistic budget," said Tanisha Warner, spokesperson for Money Management International (MMI), a nonprofit consumer-counseling organization. (MMI is the provider of the Union Plus Credit Counseling program for union families.)
In 2005, MMI helped create personalized budgets during counseling sessions for more than 180,000 clients. Warner says 39 percent of the clients counseled in 2005 attributed "lack of budgeting skills" as their primary reason for experiencing financial hardships.
"Consumers who are familiar with creating a monthly budget usually allocate amounts subtracting from total income in lieu of percentages," she said.
That's one frustrating way to budget.
Budgeting using percentages as a guideline helps you increase savings, repay and reduce debt, prevent impulse spending, distinguish between a need and a want, and identify expenses that can be reduced, Warner said.
Here's what MMI recommends: Your rent or mortgage (including insurance and taxes) should be about 27 percent of your income, minus taxes. If yours doesn't fall at exactly 27 percent, don't worry. The range typically is 20 to 35 percent.
Mortgage lenders use your gross income to determine how much house you can afford, and you can also do that with budget percentages. But to make this simple, let's deal with your net. So let's say you bring home $60,000 (round numbers are easier). Using the 27 percent figure, your mortgage should be about $16,200 a year, or $1,350 a month.
What about your transportation costs? Do you know how much of your budget should be devoted to those expenses (gas, insurance, maintenance)?
It should be about 8 percent, Money Management tells its clients.
Here is a list of budget allocations MMI recommends, including comfortable or affordable ranges:
- Personal debt (credit cards, personal loans), 14 percent, with a range of 10 to 20 percent.
- Housing , 27 percent. Range: 20 to 35 percent
- Food , 21 percent. Range: 15 to 30 percent.
- Transportation (including car loan, insurance, gas, etc.), 8 percent. Range: 6 to 20 percent.
- Utilities , 6 percent. Range: 4 to 7 percent.
- Clothing , 4 percent. Range: 3 to 10 percent.
- Miscellaneous (travel, child care, entertainment, gifts), 1 percent. Range: 1 to 4 percent.
- Savings , 7 percent. Range: 5 to 9 percent.
- Insurance (health, life, disability), 6 percent. Range: 4 to 6 percent.
- Personal care , 3 percent. Range: 2 to 4 percent.
- Health (prescriptions, eye care, dental), 3 percent. Range: 2 to 8 percent.
Keep in mind that these percentages and line items are just guidelines. They help you establish a barometer. The ranges and categories will depend on a lot of factors, including whether you're married, have children or live in a high-cost area. If 60 percent of your income is spent on housing, transportation and food, you've got to make the remaining 40 percent work by refiguring the percentages.
"Everyone is different, and everyone really does have different percentages," Warner said.
During a recent online discussion, dozens of readers asked questions that indicated to me that they hadn't figured out what percentage of their income should be spent on lifestyle expenses. Sure, some people say they budget. But then they fret and fuss and get off track because they don't have a baseline.
I know that "budget" is a bad word for many people. They hate to do it. It feels constraining. Or of those who do budget, many arbitrarily decide what they will spend.
If you had a barometer, perhaps budgeting would be easier. For example, I received this question from a reader participating in an online discussion. She wrote: "I've been married for two years and my husband and I like to shop. It's horrible. I've tried to save and it's not working. I look at how little we have and yet we still spend a lot. I can't figure it out."
I can. They don't have a plan.
This question from another reader also shows she isn't budgeting. "How do you keep from raiding your rainy day fund? I am so guilty of this (especially when trips roll around)."
You keep from raiding your rainy day fund for anything other than truly unexpected emergency by budgeting for the things that you can plan for. A vacation is not something that is unexpected. You can plan for it.
If you like to have nice and expensive clothes, that's okay. What's not okay is shopping without a budget limit.
Let's say you net about $50,000 a year. The MMI guidelines allow for about 4 percent of your budget for clothing, or $2,000 a year. Now you can split that up and buy dozens of items or splurge on one complete high-fashion designer outfit. It's your choice. But once you hit that $2,000 mark, stop shopping. If halfway through the year you're off track with, say, health expenses, then you may have to cut your clothing allowance to 2 percent or even 1 percent to balance your budget.
Using a percentage method to budget helps you remember how much you can spend in any one-expense category and overall. If you budget this way, you will have financial freedom and peace of mind.