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2 Personal Debt to Income Ratios to Know


Front-End Ratio

Indicates the percentage of income that goes toward housing costs, which for homeowners includes PITI (principal, interest, taxes and insurance premiums). Homeowners Association dues would be included in this ratio as well. Housing shouldn't exceed 28% of gross monthly income.

Back-End Ratio

Indicates the percentage of income that goes toward paying all recurring debt, including those covered by the Front-End Ratio, and other debts such as credit card payments, car loan payments, student loan payments, child support payments, alimony payments and legal judgements. Maximum for this ratio should be 36%.

Front-End Back-End Ratios

Debt Management

Debt can be an important tool if managed well. It helps people obtain what they want, manage outflows of money, or it could be a drain on resources. The best use of debt is for large purchases that normally create equity, such as a mortgage when buying a home. The use of debt such as credit cards needs to be actively managed so it does not get out of control.

Many loan officers use the following rules of thumb in assessing whether a home mortgage will be offered to a borrower.

Debt Management Rules of Thumb:

Mortgage- Rules of Thumb










The Emergency Fund


It is recommended that a sufficient amount of liquid assets be maintained at all time to handle emergencies so that there is not an immediate need to borrow money or liquidate investments at an inopportune time.

So how much should you have?

A good rule of thumb is that the client should have the equivalent of three to six months of fixed and variable expenses in liquid accounts for emergencies. Disability is one of those emergencies and disability insurance policies come with a waiting period before benefits kick in. Make sure your emergency fund is adequate enough to cover this period of time as well if it differs from the three to six month rule of thumb.




Budget: Income and Expense Categories


General Income Categories

  • Gross Salary
  • Dividends
  • Interest
  • Annuity Income
  • Settlement Payments
  • Alimony
  • Child Support
  • Trust Income


General Expense Categories

  • Housing Cost
  • Clothing
  • Food
  • Medical
  • Insurance
  • Investing
  • Utilities
  • Transportation
  • Entertainment
  • Travel
  • Miscellaneous


Steps to Creating a Budget

  1. Identify financial goals and determine what is required to reach them.
  2. Estimate Income from all sources.
  3. Estimate all Expenses.
  4. Compare income and expenses to determine if expected expenses are equal to or less than expected income.
  5. Identify areas where expenses are too high, sources of additional income and places where expenses can be reduced. Any excess should be applied to categories that bring you closer to your goal. Such as, extra income can go towards paying down accumulated debt or to investments. Remember allocating money to investments is an expense in this exercise but one that generates positive net effects.
  6. Present each category of income and expenses as a percentage of the total.





Budget Guidelines

The primary purpose for a budget is to guide and evaluate spending patterns.

General Guidelines

  • Limit the budget period to no more than one year. Preferable a calendar year so it lines up with your tax year.
  • Keep it simple and short. Too much detail can make the budget cumbersome to make and use.
  • Keep it flexible. Typically expenses follow a predictable path.
  • Avoid information that won't add to the process. Example is food purchased at a grocery store is the same as food purchased at the health food store.
  • Design the budget with specific goals in mind.
  • Budgets should be consistent in form and content year from year. Limit category changes.
  • Keep in mind that things today maybe different then in the past.

Maintaining the required records to determine whether you are living within the budget may not be easy. It sometimes can feel intrusive, but the financial rewards are significant. The use of budgeting software maybe a great place to start.

Budgeting Disadvantages


  1. If inaccurate information is used to develop the budget, it will be of little or no value.
  2. Using a budget as an absolute control on spending may preclude a person from taking advantage of opportunities that might aid in the reaching of goals.
  3. Keeping accurate spending records is often difficult, and some people resent it. However, if the person does not keep accurate spending records, the budgeting process will be wasted and will merely increase the person stress.


Budgeting Advantages


  1. Budgeting provides a way to measure financial performance. It is a self-evaluation of progress.
  2. Budgeting reveals wasteful or inefficient spending patterns.
  3. Budgeting requires the family to identify and deal with potential financial problems before they arise and consider possible alternative courses of action.
  4. Budgeting may be used to establish financial goals and determine the feasibility of meeting them.
  5. Budgeting  may provide motivation to accomplish financial goals.


8 Reasons for Using a Budget


  • To establish specific financial goals, including amounts and time frames
  • When it is important to let everyone in the family know why spending is being limited in one area or another
  • When the family economics are complex...e.g., when income and / or expenses are widely fluctuating
  • When it is important to keep track of spending in one specific area or specific individuals
  • When the family believes it is important to establish financial incentives for its members
  • Improving control of household expenses
  • Monitoring performance of specific investments such as securities and real estate
  • Meeting savings and wealth accumulation goals such as education funding or vacation, new car, and retirement planning


What is a Budget?


A budget is a tool used to plan and evaluate spending patterns. It is an estimation of all income and expenses and a financial road map for day to day living. Families who operate within a budget generally have fewer financial problems than a family that pays the bills when they come and then sees what is left at the end.

Successful budgets: generally measured by adding up all of the pluses and minuses in each category of spending, and finding that the bottom line is more or less what the budget projected it would be.



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