They’re not based on your financial best interests, and therefore they shouldn’t be used to calculate whether you can actually afford something.Ī much better way to determine whether you can afford a house or a car is to insert the payment and other associated costs into a hypothetical 50/30/20 budget. Benefit #2: It keeps your home and transportation expenses in check.Īnother good use of the 50/30/20 budget is to help determine whether you can really afford big purchases such as a home or a car.Īs I’ve noted frequently on this website, lender guidelines - such as how much house you can “afford” - are designed to maximize the lender’s profit. If so, that could be an area in which you need to focus on changing your habits - whether that means saving more money or cutting back on your spending. When you look at your current income and spending, do you find that one budgeting category is far above or below the recommended guideline? No matter where your finances are right now, measuring your current expenses against the 50/30/20 budget is a helpful exercise. Here are some of the reasons why this type of budget might make sense. Opt-in below to receive the free PDF guide instantly. Get financial control with our step-by-step goal-setting workbook. For example, if you have high-interest debt, you’d want to devote this entire 20% towards getting rid of it. You can use the baby steps framework for figuring out which goals you should be focusing on. Contributing to IRAs, 401(k)s and other retirement accounts.This is the money that goes towards achieving your financial goals, which may include: The next number to think about in this budget formula is 20%. Non-essential shopping (new golf clubs, a new Kate Spade purse, etc.).Premium and streaming TV (like HBO and Netflix).Entertainment (concerts, plays, sporting events, etc.).Here are some of the common expenses that get classified as “wants”: It includes things you want but could certainly live without. This is what some people think of as the “fun” category. They’re the things you need to survive at your current standard of living. The items in this category cover the basics of life. Minimum payments on your debt, such as credit cards, student loans, etc.Insurance premiums, such as life insurance, health insurance and auto insurance.Groceries (but not eating out in restaurants).Utilities, like your cell phone, heat, water, gas and trash.Transportation, including car payments and gas.Here are the most common “needs” that get folded into this category: This budget approach states that you should spend 50% of the money you earn on necessary items, such as housing, transportation and other bills. Here’s a quick breakdown of how a few common expenses are divided up among each of the three categories. Even if you choose not to actually use the formula for your budget, it’s a helpful framework for determining whether you can afford larger purchases like a house or a car. There’s a lot of value in measuring yourself with the 50/30/20 budget.Things get out of whack quickly for both low-income and high-income individuals and families, because your needs neither double when your income doubles nor shrink by 50% when your income declines. This approach is best for younger, average-income earners who have paid off their high-interest debt.The 50/30/20 budget divides your after-tax income into three separate categories: 50% for needs, 30% for wants and 20% for savings/financial goals.Problem #3: It doesn’t focus on your highest-leverage goals.Problem #2: It doesn’t account for geography.Problem #1: It uses percentages of income.Benefit #3: It lets you treat yourself.Benefit #2: It keeps your home and transportation expenses in check.Benefit #1: It’s a solid starting point.
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