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How should you divide your spending?

Dr. Don TaylorDear Dr. Don,
At one time there were charts everywhere recommending X percent of income should be spent on food and not more than X percent of income should be spent on housing. Where can I find that info? Do you make recommendations about this?
J. Jingler

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Dear J.,
Lenders have loan origination or underwriting standards that limit the amount of income that can go to housing expenses. Called the front ratio, it is 28 percent of income. The back ratio is housing plus other contractual expenses. The underwriting standard in mortgage lending for the back ratio is typically 36 percent of income, but lenders have become more flexible concerning the back ratio.
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If you know your marginal tax rate, you know how much of your next dollar of income is going to pay Uncle Sam. If you're in the 25-percent marginal tax rate, then 25 cents are going to federal income taxes. Add on state and local taxes, Medicare and Social Security taxes and you're in the 30 percent to 40 percent range. The IRS Web site has a convenient table of marginal tax rates, and so does Bankrate's Taxes page.

So, if one-third of your income is going toward taxes, and roughly one-third of your income is going toward housing and other contractual expenses, you only have one-third of your income for other living expenses, discretionary spending and investing for your future.

Bankrate's Budgeting 101 worksheet lets you lay out your monthly income and expenses and then shows you how you stack up against the average American that earns about what you do in annual income. Looking at where you outspend or underspend your peer group may give you some ideas on how you need to adjust your spending.

If you don't have an emergency fund and you aren't setting aside funds for your future, then it's likely you're spending too much of your income. An automatic investment program can put investing at the top of the list. Most financial institutions or mutual funds have this type of program.

The person that makes $15,000 a year is going to spend a higher percentage of his income on food, for example, than someone making $55,000 a year. Global rules of thumb just don't work in this area. That's why the Bankrate worksheet is tied to income. If you're concerned that you're spending too much on dinners out, then you no doubt are. You don't need a rule of thumb to tell you that.

-- Posted: Jan 21, 2005




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