Understanding Personal Budget Planning and Debt Ratios


If you want to control your spending and work towards your financial goals, you need a budget. A written, monthly budget is a financial planning tool that allows you to plan how much you will spend or save each month. It also allows you to track your spending habits. Whether you’re looking to create a personal budget spreadsheet or just get a better grasp on money management, start with these six steps:

Step 1: Note your net income

The first step in creating a budget is to identify the amount of money you have coming in. Include all forms of income.

Step 2: Track your spending

It’s helpful to keep track of and categorize your spending so you know where you can make adjustments. Doing so will help you identify what you are spending the most money on and where it might be easiest to cut back. Begin by listing your fixed expenses, followed by variable expenses and categorize properly. 

Step 3: Set your goals

Before you start sifting through the information you’ve tracked, make a list of all the financial goals you want to accomplish in the short-and long-term. Short-term goals should take no longer than a year to achieve. Long-term goals, such as saving for retirement or your child’s education, may take years to reach. 

Step 4: Make a plan

Use the variable and fixed expenses you compiled to help you get a sense of what you’ll spend in the coming months. 

Step 5: Adjust your habits if necessary

Once you’ve done all this, you have what you need to complete your budget. Having documented your income and spending, you can start to see where you have money left over or where you can cut back so that you have money to put toward your goals. 

Step 6: Keep checking in

It’s important that you review your budget on a regular basis to be sure you are staying on track. Few elements of your budget are set in stone: You may get a raise, your expenses may increase or you may have reached your goal and want to plan for a new one. Whatever the reason, keep checking in with your budget following the steps above.

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Using tools to achieve your financial goals

Now that you have followed the steps above and have an understanding of your money and budget, you can adequately begin planning for certain financial considerations that help you achieve your goals. Perhaps you want to borrow money to pay for a home, an education, or a new car. Now that you are tracking your finances, you can begin to utilize a couple of additional basic tools to determine just what you can afford with your given budget. To do that, you’ll want to make use of debt ratios.


What are Debt Ratios?

Debt ratios are used to figure out how much you can afford. The two most commonly used debt ratios are debt-to-income ratio and loan-to-value ratio. The debt-to-income ratio is applied first to determine the maximum amount you can borrow and then the loan-to-value ratio is applied next to determine that maximum price you can pay to purchase the item you are seeking to buy.

  1. Debt-to-income Ratio

The debt-to-income ratio is considered first because this ratio tells you how much you can borrow based on your monthly income minus your monthly debt payments. To calculate your debt-to-income ratio you must first total up all your sources of monthly income.  Then you must total up all your monthly debt payments.  Finally, divide your total monthly debt payments by your total monthly income to get your debt-to-income ratio and multiply that number by 100 to get the percent.

For example:

        • Add up your monthly income (salaries, overtime, dividends, etc.)
        • Add up your monthly debt payments (mortgage or rent, credit card minimum payments, car loan, student loans, alimony/child support, other loans, etc.)

Then calculate your debt-to-income ratio:

Monthly debt payments / Monthly income x 100 = Debt-to-income ratio

So, let’s say your total monthly income is $5,500 per month and your total monthly debt payments is $3,100.  Your debt-to-income ratio would then be calculated as follows:

$3,100 / $5,500 x 100 = 56%

Your final result will fall into one of these categories:

        • 36% or less is the healthiest debt load for the majority of people.
        • 37%-42% isn’t a bad place to be. If your ratio falls in this range, you should consider reducing you your debts
        • 43%-49% is a ratio that indicates likely financial trouble. Start paying off your debts now to prevent an overloaded debt situation.
        • 50% or more is a dangerous ratio. You should be aggressively paying off your debts. Don’t hesitate to seek professional help.


  1. Loan-to-value Ratio

The loan-to-value ratio is calculated by dividing the loan amount by the property’s value.   This ratio is used to determine how much money you can borrow based on the value of the property. To calculate the ratio you first need to know the market value of the property you are seeking to borrow against.  To get the market value, the creditor will typically require you to hire a qualified appraiser to prepare an appraisal report of market value.

For example, let’s say you are applying for a loan for a house and it is determined by an appraiser that the market value of the house is $200,000.  You now have the first number of the equation. Next, you need to know what ratio the creditor is willing to work at.  Most creditors will lend up to 80% to 90% of the value of the property. So now you have the second part of the equation.

To put it all together here is the calculation to determine how much you can borrow:

Market value of property         $200,000

Creditors given rate                x 80%

Maximum Loan Amount           $160,000

Now you have to calculate the amount of funds you will need on hand to complete the loan agreement.  This is simple.  Simply subtract the Market value of the property from the Maximum Loan Amount to get the amount of deposit you will need to have to get the loan.  Example:

Market value of property – Maximum Loan Amount = Deposit Amount Required

$200,000 – $160,000 = $40,000

Creditors work at different rates so a creditor who works at a 90% loan-to-value rate means that you will need less of an initial deposit.  This is one reason why you should shop around.


Ready for the next step

Now you have successfully calculated the maximum amount of money you can borrow. Don’t be afraid to start small. Just because you may qualify for a large loan doesn’t mean that it is a smart financial decision to buy as large a home as possible. Take a careful look at your family budget and your housing needs before you decide how much you can really afford.

To help you get started, download our sample MS Excel worksheet to help you create a budget for you and/or your family. Just click on the link below and then save the file on your desktop:

Personal Budget Worksheet


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