We are intrigued by the concept of financial intelligence and found it appropriate to share and discuss this topic in hopes to help someone.
We have read and researched many financial articles and books on this topic. One book, Rich Dad Poor Dad by Robert Kiyosaki talks about cash flow and the fact that you can build your financial IQ through education. Is it really that simple? It is! Education is key to building a Financial Brick House.
So, where do you start?
When you’re on the brink of a financial crisis (living on Paycheck to Paycheck), or have recently lost your job, you are often always faced with one question “who do I pay first?”
You may not be on the brink, but you still wonder, where has my money gone?
Maybe you just don’t want to think about it, aren’t good with numbers or you don’t have the discipline to keep track of all your spending. Either way, keeping a handle on your cash is tricky, and that’s why we’re here to help.
So, let's discuss your needs and wants.
Understanding how your money is spent means understanding the difference between your needs and your wants.
So, what is the need?
A need is something you must have in order to survive, for instance, food, shelter, or clothing.
Now, what’s considered a want?
A want is something you would like to have and isn’t necessary for your survival, but you would really like to have it. For instance, designer clothes, an iPod, or a vacation.
Although it may seem trivial, having concrete examples of each will help ensure you navigate through your emotions when making a purchase. Good money management is the steps you take to ensure you have enough money to cover all your “needs” while still being able to purchase your “wants.” But only when you have extra money to do so.
When you get to the stage of being able to accept your needs Vs. wants, you can go on to understand the following:
1) Who you should pay first.
So, who should you pay first?
✔ You should always pay yourself first so you can build an emergency fund.
✔ Pay off all your main bills, for example, utility bills, housing bills, and food.
✔ Lastly, pay off your credit cards.
Now that you understand who to pay first, you can budget. And why is budgeting so good and how is it possible?
A budget tells the story of how much you make and where does your money go, and how much, if any, goes toward savings.
With a budget, you learn to stay in your lane and live within or beneath your means. You start to question yourself when spending money and create clear goals for your financial future. In turn, this means you create a clearer picture of your financial situation and learn to spend your money more wisely.
When learning to budget, divide and allocate these three different funds to make sure that you have future cash flow: Emergency fund, your YOLO fund, and your long-term savings. We are recommending that you do this in addition to listing ALL of your income and expenses. We will go into more detail below.
Now that you have a clear picture of what budgeting is all about, why don’t we get into building your funds?
How do you build an emergency fund? To begin with, allocate 10% of your earnings towards this fund. If you do not have enough time to save, do not worry! Now is a good time to start, even if your financial situation isn’t at its best, then there are short and long-term solutions to that.
You may ask which you can do faster to begin your emergency fund? Earn more money or cut down expenses?
Cutting down your expenses is easier when looking at your budget and developing an emergency fund. Getting a new job to earn more money may take some time while eliminating unnecessary expenses can be addressed right now. Another alternative is to begin a side business to supplement your income. Again, this will take time to research, develop and implement. So, why not start by addressing your current expenses?
Yes, we recommend that you develop a You Only Live Once (YOLO) fund by allocating another 10% of your earnings to this account. I don’t know about you, but we all need this fund to make sure there is a life-work balance. You can use this fund to pay for eating out, going on vacations, getting your hair done and purchasing the things that make you happy. It is just that easy, just plan for it ahead of time.
Can you guess how much you should allocate to this fund? 10% of your earnings should be put towards your financial future; this is the backbone of your finances.
If you struggle to save, then check out these tips to help you in the long term:
✔ Be organized. Write out all your earnings. It does not have to be sophisticated or an elaborate spreadsheet, you can even get a notebook. Draw vertical lines in the middle of the page, write your income on one side and all your other expenses on the other.
✔ Be realistic. When writing out your expenses make sure to include everything from daycare, summer camp, hair, nails, allowance, automatic deductions from your account, you get the picture.
✔ Make room for improvement. Now that you have all your expenses laid out in front of you, see if there’s some wiggle room to help you save some more.
✔ Your budget is fluid: You can revise your budget monthly to make sure you are making the progress you desire.
You may be wondering why staying organized is so important:
1. It keeps all your finances in order.
2. You save more money.
3. You open a floodgate of opportunities for yourself and your family.
Time to craft your budget!
Start by putting your income on top, including your employment/self-employment, rental properties, and social security. Now you can go on allocating some of your money to your savings, list all your expenses, and your auto deductions. If there are any extra expenses, pop them down too and create a miscellaneous category if you cannot decide which category to put them. The idea is to get a full financial picture of your household income and expenses.
3) Good Debt Vs Bad Debt
Have you ever heard about good debt and bad debt? Which do you have and what’s the difference?
Good debt benefits your life for example, you have something that is of value to you that you keep even after paying off your debt. Good debt creates opportunities for the future but depending on the market and circumstances a good debt may be a debt as well.
Here are some examples of good debt:
Student loans are a good debt because it increases your earning potential when you graduate. However, one common pitfall is when you graduate and don’t factor in your student loan debt into your budget. For example, you may get a new job and decide to buy a home, new car, furniture without planning for the impact it may have on your financial wellness. In other words, the more money you make the more you may spend.
A mortgages is considered a “good debt” by creditors. The mortgage debt is secured by the value of your house, lenders see your ability to maintain mortgage payments as a sign of responsible credit use. It is important, if at all possible to never be late on a mortgage payment. Lenders look at your mortgage history as a sign of stability.
Home Equity Line of Credit (HELOC)
HELOC’s are an attractive way to pay down debt due to the low interest rates it offers. If it advisable to pay down the debt but be careful not to run up the debt again or you will be back to square one or in a worse position. Additionally, if you are looking to consolidate your debt try looking for a low interest credit card first because defaulting on these loans can jeopardize your home.
This is the process of merging all of your credit cards and loans into one payment usually at a lower interest rate. This is a good option if you have good credit score. Again, it is not a good idea if you do not have a sound financial plan to not run up your credit cards again.
Now you know what good debt is, what’s bad debt?
On the contrary to good debt, bad debt doesn’t give you long-term benefits. It only gives you just that, a debt.
Some examples of bad debt are:
It is a bad debt in the sense that automobile depreciate in value as soon as you drive it out of the parking lot. In addition, auto loans have a fairly higher interest rate than most loan. Auto loans are the third largest debt category in the US, Mortgages and Student loan taking first and second place.
These are short-term loans that are meant to be paid right away because of the astronomical interest rates. It is advisable to try other options before resorting to payday loans (aka payday advance, salary loan, payroll loan, small dollar loan, short term, or cash advance loan.
Credit cards may be a good debt if it used responsibly because it helps to build your credit score. It is, however, a bad debt because the interest rates are generally higher than a loan. Also, if you only pay the minimum balance, you can take a very long time to pay off the debt. Lastly, if you keep your balance the credit limit, your credit score decreases.
What’s your debt to income ratio? Why are we talking about this in this article? Because we have explored and created your budgets and since you already have this information handy, why not calculate your debt-to-income ratio? This gives you a picture of what lenders will see when you are looking to secure a loan.
If you’re not sure how to work it out, check out these tips:
1. Add up all your monthly debts.
2. All your credit card payments.
3. Your auto, student or, loan payments.
4. Monthly alimony or child support payments.
5. any other debts you have that will show up on your credit report.
Now you’ve added all these up, divide the sum of your monthly debts by your monthly gross income (your take-home pay before taxes and other monthly deductions.) Convert the final figure into a percentage and once you’ve done that, you’ll have your DTI ratio.
An example of this is: If your monthly debts equal $2,500 and your gross monthly income is $7,000, your DTI ratio will be about 36% (2,500/7,000=0.357.)
Now, let’s apply this to a mortgage loan.
What is it and how does it work?
The front-end ratio, also called the housing ratio is essentially the percentage of your monthly gross income that goes towards your mortgage payments. It is calculated by dividing your anticipated monthly mortgage payments by your monthly gross income. In addition, lenders also consider other associated costs, such as homeowners association (HOA) dues, if applicable. Lenders prefer the front-end ratio to be no more than 28% for most loans and no more than 31% for FHA loans.
Your back-end ratio measures how much of your income is allocated to all other monthly debts. It is the sum of all other debt obligations divided by the sum of the person's income. Other debts commonly include student loan payments, credit card payments, non-mortgage loan payments. Lenders prefer to have a ratio of no more than 36% to make sure there is not a high risk of defaulting on a loan.
Now we’ve reached the end of this article, why don’t you use these tips to help you get started on saving some money so you can afford to buy the things you really like? Get started today.