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Week of 10.2.09

Five Things That Consume More Than 50% of Your Income
by Manisha Thakor

Manisha Thakor
Learn more about Manisha and ask her your questions
In these recessionary times, financial tips are flowing fast and furious about how to save money and stick to a budget. Facing a sea of information many people are asking, "Where do I start?" For most of us, five areas of spending will consume over 50% of the money we earn during our lifetime, so that's the best place to begin. The five areas are: Home, Car, Kids, Education, and Retirement. Here's what you need to know about each:

1. Don't bite off more HOME than you can chew. How much house can you comfortably afford? For most people the answer is a house with a purchase price of no more than 3 times their annual household income. That's because the cost of a home includes much more than the monthly mortgage payment; there's also property tax, insurance, upkeep, etc. Typically these costs run 2% to 3% of the price of your home each year. Assuming a 20% down payment, a 30-year fixed rate mortgage, and interest rates in the 5%-6% rate, the 3 times your income rule of thumb will translate into total housing costs of roughly 30% of your gross income.

2. Don't let your CAR drive you to the poor house. The same logic that applies to your home applies to your car. Most people can comfortably afford a car that is one-third of their annual income. If you make $60,000 you can comfortably afford a car that costs $20,000. A car has many other costs beyond the monthly payment. There's insurance, gas, parking, maintenance, etc. If you follow this rule of thumb, your total transportation costs should be 10% or less of your gross income.

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3. Don't let your KIDS kick you in the wallet. Kids are expensive. The Department of Agriculture estimates it will cost $220,000 to raise a child born in 2008 to age 18. And that figure is before you add in the cost of college! Deciding to be a parent is a major financial obligation. Don't make it worse by over-indulging your love bundles.

4. Don't forget to ask "How high is too high for higher EDUCATION?" It used to be good debt was defined as mortgage and student loan debt and bad debt was everything else. Not any more. We've now learned that too much of a good thing can indeed be bad. Rough rule of thumb, don't take on more in total education debt than you think you are going to earn on average annually during your first 10 years after graduating (from either college or graduate school). If you think you'll make $50,000 a year, don't take out more than $50,000 in loans. If it takes you more than 10 years of paying 10% of your income a year in student loan repayments, it's going to be tough to meet your other financial obligations.

5. Don't underestimate the need to feed your RETIREMENT nest egg. How much will you need to retire? A simple rule of thumb is to multiply your current income by 25. So if you make $50,000 a year and want to maintain that standard of living in retirement, you'll need a nest egg of at least $1,250,000. Understanding as early on in your working life as you can what "your number" is will help you see how important it is to plan for this savings goal.

Note: The answers provided by Manisha Thakor represent solely her opinion and do not represent the opinion of NOW or its producers, who bear no responsibility for them. These answers do not necessarily reflect knowledge on Thakor's part of all factors relevant either to the circumstances of the questioner, or to circumstances experienced by others in their own situations. You therefore should consult with, and solely rely on, your own professional advisors before making any material financial or legal decision rather than on the answers provided here.
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