Related Ratios
“Don’t buy things; buy freedom.” - David Furtrelle
Last week, Maria Niles, the Personal Finance and Real Estate contributor at BlogHer, pointed readers to Linda Stern and her review of a Journal of Personal Finance article posing this question, “If you were a company, what would the analysts be saying about you?”
Stern writes, “Most investors use financial ratios to grade the companies they buy and sell, but they rarely subject their own finances to the same rigorous reviews. Now, an investment adviser has suggested that his clients measure themselves against key ratios, too. Ratios can serve as an important tool, a guideline, to help convey to individuals how their income, savings and debt are related, and how those ratios must change over time.”
“Of course, mortgage lenders have long used ratios to determine whether applicants are credit-worthy. Typically, they like to limit your housing expenses to 28 percent of your gross income, and your total debt payments to no more than 36 percent of your income. To figure out if you’re within that range, add up what you spend in a month on your mortgage, home insurance and real estate taxes, and divide that figure by your monthly gross income. Your answer should be under .28.”
“Go back and add in your car payment, credit card payments and other debt payments to the first total, and divide again by your monthly gross salary. The answer should be under .36. A financially healthy family or individual will look different at different ages, and adjusts his ratios accordingly.”
Here are the numbers suggested just for the savings ratio: “Everyone, at every age, should save 12 percent of their income every year. Savings amassed at 40, 50 and 60 should be 1.7 times income, 3 times income, and 8.8 times income. Don’t include home equity in your savings for this calculation, unless you are committed to selling your home and moving to a cheaper place when you retire.”
In California, most people include home equity as part of their savings calculation. According to an article in the Washington Post, Kenneth R. Harney believes, “Equity levels are important measures of household financial health and a key component of net worth. Low equity makes owners more vulnerable to economic shocks and rising interest rates. If these owners had to sell in a pinch, they could find themselves walking away with little or nothing at the end of the transaction. If property values declined even modestly, large numbers of recent buyers with minimal equity stakes could slip to the negative side.”
“It is true that a surprisingly large percentage of recent homebuyers have minimal, even negative, equity levels. How big is your home-equity cushion? How much more is your home worth compared with the debt you’ve loaded onto it -- primarily your first and second mortgages and credit lines? Do you have a 20 percent equity stake? Less than 10 percent?”
What is the significance of the above stories? Well, it’s all about risk. Homeowners on both coasts should mind their debt ratios and not bank on appreciation rates to bail them out. Those days are over. Hunker down. Save more, spend less and get into a fixed-rate mortgage. It takes income, discipline and time… most people have income and we all have time. The clincher is discipline. Discipline is the commonly shared trait that turns common into wealthy.
Last week, Maria Niles, the Personal Finance and Real Estate contributor at BlogHer, pointed readers to Linda Stern and her review of a Journal of Personal Finance article posing this question, “If you were a company, what would the analysts be saying about you?”
Stern writes, “Most investors use financial ratios to grade the companies they buy and sell, but they rarely subject their own finances to the same rigorous reviews. Now, an investment adviser has suggested that his clients measure themselves against key ratios, too. Ratios can serve as an important tool, a guideline, to help convey to individuals how their income, savings and debt are related, and how those ratios must change over time.”
“Of course, mortgage lenders have long used ratios to determine whether applicants are credit-worthy. Typically, they like to limit your housing expenses to 28 percent of your gross income, and your total debt payments to no more than 36 percent of your income. To figure out if you’re within that range, add up what you spend in a month on your mortgage, home insurance and real estate taxes, and divide that figure by your monthly gross income. Your answer should be under .28.”
“Go back and add in your car payment, credit card payments and other debt payments to the first total, and divide again by your monthly gross salary. The answer should be under .36. A financially healthy family or individual will look different at different ages, and adjusts his ratios accordingly.”
Here are the numbers suggested just for the savings ratio: “Everyone, at every age, should save 12 percent of their income every year. Savings amassed at 40, 50 and 60 should be 1.7 times income, 3 times income, and 8.8 times income. Don’t include home equity in your savings for this calculation, unless you are committed to selling your home and moving to a cheaper place when you retire.”
In California, most people include home equity as part of their savings calculation. According to an article in the Washington Post, Kenneth R. Harney believes, “Equity levels are important measures of household financial health and a key component of net worth. Low equity makes owners more vulnerable to economic shocks and rising interest rates. If these owners had to sell in a pinch, they could find themselves walking away with little or nothing at the end of the transaction. If property values declined even modestly, large numbers of recent buyers with minimal equity stakes could slip to the negative side.”
“It is true that a surprisingly large percentage of recent homebuyers have minimal, even negative, equity levels. How big is your home-equity cushion? How much more is your home worth compared with the debt you’ve loaded onto it -- primarily your first and second mortgages and credit lines? Do you have a 20 percent equity stake? Less than 10 percent?”
What is the significance of the above stories? Well, it’s all about risk. Homeowners on both coasts should mind their debt ratios and not bank on appreciation rates to bail them out. Those days are over. Hunker down. Save more, spend less and get into a fixed-rate mortgage. It takes income, discipline and time… most people have income and we all have time. The clincher is discipline. Discipline is the commonly shared trait that turns common into wealthy.
posted by Nina Smith at 6:03 AM
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