Many people make the mistake of living beyond their means. This is the best and quickest way to get into debt. If you would like to avoid getting into debt understanding your debt to earnings ratio is very important.
Do the Math
First and foremost it is important to understand your earnings and cash flow. Most Canadians do not take the time to do the math and look at how much money they have coming in and how much they must spend to survive. Your debt to earnings ratio provides you with a number that allows you to see how healthy your finances are using these three simple steps:
1. Calculate all of the money coming into your home monthly to determine your recurring monthly earnings
2. Calculate all of the bills you must pay and all expenses including gas, groceries, lunches, insurance, credit cards, loans, taxes and of course major costs such as rent/mortgage to determine your recurring monthly debt
3. Deduct your expenses from your monthly income to see what is left
Your Debt to Earnings Ratio
Once you understand how much money you have left at the end of the month, or worse, how much money you are short, you can determine your current spending habits and where changes are needed. Lending institutions use a simple calculation called a debt to earnings ratio to determine how well you are managing your money. This is calculated by dividing your monthly debt by your monthly income. The ideal number is 36. The higher your number, the worse your finances.
Budget Tips
If you come out ahead, even by a small amount, this is good. The higher your number, the more important it is for you to set a budget to avoid getting further into debt. If you are above 36 you can use the following budget tips:
* Stop using credit cards and start a cash only policy
* Look at where your money is going such as rent, utilities and groceries and reduce spending wherever you can
* Reduce entertainment, pampering and dining out costs
* Start using Canadian printable coupons when you can
* Set a grocery budget and stick to it by using flyers and Canadian printable coupons
* Speak to your bank about consolidating debts such as credit cards and loans so you have one low, monthly payment
Understanding your debt to earnings ratio will allow you to see where your money is going and avoid getting further into debt.