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Financial Planning Financial Ratios

Businesses and financial institutions have long used debt, income, and savings ratios to evaluate company performance and the credit worthiness of prospective borrowers. Individuals can also use financial ratios to measure and plan their own personal finances. Here are some of the more helpful financial ratios:

Total payment ratio:

The total payment ratio is a measure of an individuals ability to pay his or her monthly debts.

The rule of thumb is that a total monthly debt payments should not exceed 36 %to 38% of the individual’s monthly gross income. Monthly debt payments include child support, alimony, credit card debt, and other debts and gross income is not reduced by taxes or employer or employee withholdings.

Therefore, a family that earns $8,000 per month should not have monthly total debt payments in excess of $2,880 and a family that earns $4,000 per month should not have a monthly mortgage payment in excess of $1,440.

Housing payment ratio:

The housing payment ratio is a measure of an individuals ability to pay his or her monthly home mortgage payment or monthly rental payment.

The rule of thumb is that a monthly home mortgage payment should not exceed 28% of the homeowner’s monthly gross income. Monthly home mortgage payment figure includes property taxes, insurance, and loan principal and interest and gross income is not reduced by taxes or employer or employee withholdings.

Therefore, a family that earns $8,000 per month should not have a monthly mortgage payment in excess of $2,240 and a family that earns $4,000 per month should not have a monthly mortgage payment in excess of $1,120.

Savings ratio:

The savings ratio is a measure of how much an individual should be saving.

The savings ratio is calculated by dividing an individual’s annual savings per year by his or her gross income. The rule of thumb is that an individual’s savings ratio should be between 8% and 25%, with younger individuals having a savings ratio closer to 8% and more mature individuals having a savings ratio closer to 25%.

Therefore, a family that earns $100,000 per year should be saving $8,000 to $25,000 per year and a family that earns $50,000 per year should be saving $4,000 to 12,500 per year.

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