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What Can You Really Afford?

by Keith Rawlinson
Volunteer Budget Counselor


Is your mortgage or rent payment too high for your income?  Is your car payment too high for your income?  What can you really afford to spend on gift giving each year?  Good questions.  How do you know what you really can and cannot afford?  This article will explain how to use some basic guidelines to answer these questions.  Why is this article only talking about mortgage/rent, car payments and gift giving?  Because these are the areas of a family budget where the most overspending commonly occurs causing financial stress and keeping people from getting ahead with their finances.  To figure out what your guidelines should be for all areas of spending, read the article You Need a Plan.

When I say 'guidelines' I'm talking about a concept called 'Percentage Guidelines.'  It sounds impressive, but all it really means is the percentage of your income that you can afford to spend on the expenses I mentioned above.  The Percentage Guidelines I'm about to give you are based upon your average take-home pay.  I'm not talking about your gross pay; I'm talking about how much is left after your employer makes all of the deductions from your pay for such things as FICA, income tax, dues,  insurance and so forth.  I explain how to calculate your monthly take-home pay in the article You Need a Plan.  

How much mortgage or rent payment can you afford?


First of all, understand that I am not talking about how much mortgage payment you can manage to pay.  If you don't mind spending the rest of your life broke and financially stressed, then you can possibly manage to make a much larger mortgage payment than I am telling you here.  The mortgage payment I am figuring out here is one that is reasonable, do-able and can be done pretty much stress-free.  The mortgage payment I'm calculating here is one that should allow you enough room in your budget to get out of debt, save up some money and start working toward becoming wealthy.  You may not have as big a house as you want, but you'll have one that you can afford.

If you are trying to get out of debt and become wealthy, then you can afford a mortgage payment of around 20% of your monthly take-home pay.  To figure this out,  just multiply your monthly-take-home pay by .20  (point two zero).  Here is an example:

Monthly take-home pay is $2,800 so 2,800 X .20 = $560 per month.  

This amount may seem awfully low to you, but it is possible to have a mortgage payment this low if you buy a smaller house, or a house in a different neighborhood, or save up a larger down payment.  Could you make a larger payment than this?  Probably--but not if you are trying to become debt free and wealthy.  Now please realize that 20% of take-home pay is just the 'ideal' amount for a mortgage payment.  You can usually go as high as 25% and still be okay, although it will take you a bit longer to get out of debt and become wealthy.  This upper amount is calculated by multiplying your monthly take-home pay by .25 (point two five).  For our previous example, this new amount would be:

$2,800 X .25 = $700 per month

Quite a bit more, but remember that it will be more difficult to save, get out of debt, and become wealthy with this higher amount.  Still possible, but it will require more time and a bit more financial stress in your life.  Whatever you do, though, don't take on a mortgage payment more than 25% of your take-home pay.  Also, keep in mind that lending institutions (banks, credit unions, etc.) will often qualify you for a much higher payment than 20%, and that being qualified for a larger payment doesn't mean you can afford it--especially if you are trying to eliminate financial stress from your life.  For more information about getting a mortgage, be sure to read the article What Kind of Mortgage to Get.

What about rent?

To do a calculation to figure out how much rent you can afford, do the same calculation we just did using the 25% guideline.  The reason you can afford more rent than you can mortgage is because owning a house also requires taxes, additional insurance, and maintenance.  When you rent, the landlord generally takes care of these things.

How much car payment can you afford?


First of all, I recommend having no car payment--ever!  It is very possible to drive nice cars and have no car payment.  I have done it and so have many, many others.  To find out how, read my article How to Never Have a Car Payment Again.  But, if you insist on having monthly car payments, the guideline is to pay no more than 6% of your monthly take-home pay in car payments.  To figure this out, you multiply your take-home pay by .06 (point zero six).  You need to understand that this amount represents what you can afford for all of your car payments combined!  So, if there is more than one car payment coming out of your take-home pay each month, then this 6% needs to cover all of those car payments added together.  In our example, the total for all car payments combined is:

$2,800 X .06 =  $168 per month in car payments.

Yes, I know this doesn't seem like much, but it is a lot when you consider that you can have no payments at all after you read the article I referred to above.  If you need to get your car payments down, you can buy a less fancy car, buy an older car, or save up a larger down payment.  If your total car payments are much more than this 6% guideline, those payments are likely to be a source of financial stress in your life and are going to make it much more difficult to get ahead, get out of debt, and become wealthy.  Remember, that I recommend having no car payments at all, but if you insist upon it then do not spend more than 6% of your take-home pay on car payments.

Gift Giving

Keep in mind that gift giving includes all of your gift giving including Christmas, Holiday, birthdays, graduations, anniversary, special occasion, etc.  Gift giving is an area of spending where most people have a great deal of trouble.  Overspending in gift giving keeps a lot of people in financial stress.  The guideline for gift giving for the entire year is 1.5% (one point five percent) of your annual take-home pay.  Take your monthly take-home pay amount, multiply it by twelve to get your annual take-home pay amount, then multiply that by .015 (point zero one five).  In our example that would be:

$2,800 X 12 = $33,600 annual take-home pay.

$33,600 X .015 =  $504 to spend on gift giving for the entire year.

Again, this doesn't seem like much, but gifts don't have to be expensive store-bought gifts.  You could buy less expensive gifts (it really is the thought that should count); or give homemade gifts; or give gifts of your time for such things as free babysitting, pet sitting, house cleaning, car washing, etc.  You could continue to be extravagant in your gift giving and overspend, but it is really difficult to do that and become debt free and wealthy.

Conclusion

Limiting your spending in the areas of mortgage / rent, car payments and gift giving is critical to eliminating financial stress and to having the extra money needed to eventually become wealthy.  If you don't have control of these three areas of your budget, it will be nearly impossible for you to have control of the rest of your spending.  And don't forget that, although you may be settling for less house, less car, and cheaper gifts now, once you are debt free and wealthy, you will be able to move up to a bigger house, a nicer car, and more extravagant gifts.


To learn a lot more about saving, investing, eliminating debt and becoming wealthy, please read the articles on the Financial Page.  There, you will find a veritable treasure of what to do and how to do it.


Please know that all of the thoughts, information, suggestions and techniques given on this site are nothing more than the author's opinion on the matter being addressed.  Do further research before making any decisions.

This article copyright 2007 by Keith C. Rawlinson (Eclecticsite.com).  All rights reserved.

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