5 Money Ratios Every Clever Girl Should Know

Money Ratios

It can be difficult to gauge the health of your personal finances, especially when it comes to deciding how much to allocate towards wants versus needs, spending on credit and figuring out how much debt is just too much.
 

"One way to make quick determinations about your finances is to use money ratios."
 

Money ratios provide guides and rules of thumb to help you quickly evaluate your financial situation and offer direct insight on how to improve it. Ease through your next money check-in with these 5 money ratios that every Clever Girl should know.  

 

1. 50% Budgeting

There are many ways to budget, but according to the 50/30/20 budgeting approach the cost of your essentials should be no more than 50% of your after-tax income.  Where, essentials include housing and related expenses, transportation, food any other must-have costs.  
 

- Why it's important

This ratio highlights the importance of keeping the must-have costs at a level that allows you to consistently contribute to savings and investing for the long-term, with ample room for wants too. Essential costs that top 50% of your income, put your finances in a precarious position, with little room for error.  
 

- How to apply it to your finances

First, figure out this ratio your essential expenses as a percentage of your current after-tax income. An easy way to identify these essential costs is to include the costs you would still have to pay if you had a drop in income or became unemployed, including your minimum debt payments.  
 

A result of over 50%, calls for increasing your income, paying off debt obligations faster, reducing other fixed must-have costs or a combination of these.  

 

 

2. Credit utilization rate

The ratio of the sum of your revolving credit account balances to the total of all your credit account limits, is called utilization. This tells you how much of the revolving credit available to you is being used. For example, if you own one credit card with a $10,000 credit limit and a current balance of $2,000, the utilization rate would be 20%. 

$2,000/$10,000 x 100 = 20% Utilization
 

- Why it's important

Credit utilization is a major factor in your FICO score, accounting for 30% of how your score is calculated. This means that the higher your credit utilization ratio is, the more negatively impacted your credit score will be. Even more important than the impact on your credit score, a high utilization, could indicate that an unhealthy reliance on debt, along with high interest costs on outstanding revolving debt. 
 

- How to apply it to your finances

Your credit utilization is a good ratio for gauging its effect on your credit score. But, when it comes to your revolving debt, budgeting for your spending on credit, not carrying or adding to your balances, and paying off outstanding debts, is the best approach. This way, your utilization is something you can be aware of, while you focus on positive cash flow and avoiding ongoing revolving debt balances all together.  

 

 

3. Debt to slay ratio

The debt-to-starting salary ratio can be used to estimate the maximum amount student loans to borrow for a particular degree program. This ratio is a measure of the amount of student loan borrowed divided by the expected starting salary after graduation. As a rule of thumb, students should limit their debt-to-starting salary ratio to a value of 1, in order to repay the loans over a 10-year period. 
 

-Why it's important

Calculating the exact ROI (return on investment) for a college degree may be difficult, so the debt-to-salary ratio provides a simple guide for college students and their families to avoid over-borrowing. When this rule is applied to borrowing, it’s easy for prospective students to understand that borrowing $60,000 for a degree that leads an average starting salary of $27,000 does not make financial sense. 
 

- How to apply it to your finances

Limiting your debt-to-salary ratio to 1, when borrowing for a college education is a good guide. However, it is important to understand that the size of the monthly payments, using this rule of thumb, depends on the average interest rate on your student loans. 
 

For instance, an undergraduate student with a debt-to-salary of 1, and total student loan debt of $27,000 at an annual interest rate of 3%, can expect to make monthly payments of $259 (representing 11.5% of the gross starting salary), for 10 years. That same student loan debt amount at a 5% or a 7% annual interest rates, would result in monthly payments of $281 and $315, respectively, over the 10-year repayment period. 
 

A more conservative debt-to-income ratio of 0.7, would be more appropriate and result in student loan payments under 10% of a borrower’s gross income.  
 

 


4. Loan to value ratio

The loan-to-value- ratio (LTV) is the measure of the mortgage on a property to its appraised value, expressed as a percentage. Lenders use this ratio as apart of the mortgage approval process, as well as, for refinancing and home equity line of credit applications.  
 

- Why it's important

As potential buyer, the loan-to-value ratio can dictate whether you will pay additional costs, like private mortgage insurance (for a LTV of less than 80%), and for existing home owners, the LTV determine whether you can refinance a lower interest rate or access a home equity line of credit. For homeowners, the LTV also represents how much equity has built up in your home, i.e. how much of the mortgaged property you own.  

 

- How to apply it to your finances

If you are a potential homebuyer, it’s critical to understand how different down payment options will affect the LTV of a home you purchase.  
 

For example, to avoid PMI costs and get the best mortgage interest rate possible, a 20% down payment will be required. Keep in mind too that mortgage interest rates & PMI costs have inverse relationships to the size of your down payment. Meaning the lower the down payment (and the higher the LTV) the higher the mortgage interest & PMI costs a home purchase. 
 

The LTV of your home also factors into how soon PMI can be removed from your mortgage, and can increase when additional debt is secured by your home through home equity loans or lines of credit. Or, after a sharp drop in a property’s market value, as was the case for many homes during the great recession. The bottom line is the lower the LTV of your home, the better. 
 

 


5. Debt to income ratio

The sum of all your monthly debt obligations divided by your gross monthly income, expressed as a percentage results in your debt-to-income ratio (DTI). DTI is another metric that lenders use when issuing loans, but can also be used to evaluate when your personal debt load approaches the danger zone. 
 

-Why it's important

A high debt-to-income ratio can affect your ability to qualify for a home loan, prevent you from managing debt payments and limit the how much you can commit to saving and investing of your financial stability. It can also stand in the way of getting approved for a home loan, even with a high credit score and income. 
 

-How to apply it to your finances

Use this ratio to identify how much of your income is going to repay debt, with interest and motivate you to accelerate your debt pay off, by increasing your income, cutting your expenses or both. 

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Although though these money ratios may not give you all the answers about your finances, use them to give you a solid approach to your finances. 


 
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Article by Melisa Boutin, a personal finance expert passionate about helping millennials in the U.S. and the Caribbean. Read her bio and visit her website here.