Transforming your Financial Life

How many times have you been frustrated with financial limits?

How many times do you reach a point where you want to do something, or have something, but realize you are facing financial limits?

How many times do you encounter the monthly grind of paying bills and wondering where did all the money go?

Welcome to life!

Many of us –in our own way and on our own level—have faced or are now facing financial challenges. Most importantly, among the many ways to solve this is, first, we must not make judgments about our financial limits; and, second, we must come to realize that IF we desire to have a better financial circumstance, then it is important that we are honest with ourselves.

Part of being honest with ourselves is our firm decision of transforming our financial life to one of financial security and abundance than that of financial insecurity and scarcity.

We do this in many ways starting with taking a full financial inventory or making an assessment of our current financial condition.

Taking Financial Inventory

The tools employed in making this assessment of financial condition begins with a financial inventory. We actually take stock of where we are financially, so that we may face the honest truth of our current financial condition.

Monthly income and expenses

Begin with making a list, or using the budget worksheet, to take inventory of all monthly sources of income. We’ll detail out all the amounts in monthly expenses, so we may know exactly what it is we have to work with in terms of money that’s coming in and the money that’s going out. The most effective way of doing this is we want this assessment to be as accurate as possible, and we want to have the bills, receipts and records of expenses for the information it may yield in other important points we’ll review later.

Measuring the amount of income and the various sources of income helps us understand not only the gross income vs. net income on wages/compensation, but it helps us see how much is left in our paycheck after all the mandatory and voluntary deductions stated on our payroll earnings statement. In contrast to the income, we also do likewise for the expenses we pay out each month so that, first, we have an awareness of what monies we spend each month in the amount, but also what we spend each month in each category of expense.

To take the total monthly income, we subtract our total monthly expenses and we then arrive at the amount of disposable income (DI). This disposable income is something we have left at the end of the month to save, invest or set aside for retirement or emergency planning.

Remember the (DI) issue as I will return to that later to discuss an alternative in how you may consider rearranging the order in which you pay out monies for expenses.


Short-term and long-term debt obligations

We then make an inventory of our total debt structure. We want to know how much we have in total debt in both short-term as well as long-term debt. We define short-term debt as any debt we may that could be if needed paid off within 1-year. Conversely, long-term debt is any debt that would take more than 12 months to repay. In each of these two groups, we have secured debt and unsecured debt. For example, a credit card is an unsecured debt while a car payment is a secured debt. Your home mortgage is not computed in your debt analysis at this stage.

We then move to total all short-term debt and all long-term debt. Here, we want to know what percent of our total annual income does our short-term debt represent and what percent of our total annual income does our long-term debt represent.

Tier 1 – 15 Percent

At 15 percent, Americans may have enough remaining income to allocate on expenses such as housing, food, transportation, and etc.

Here’s a diagram that shows how to divide the expenses


We have to be always prepared for any unlikely events that could happen anytime. Most of us would want to secure a health emergency savings or insurance, but even if we don’t have and we will be forced to owe from somebody else in the future, then we can still keep at a manageable level of 15 percent.

Just a point of reference, an annual income of $35,000 gives a monthly income of $2,917. This will give a debt-to-income ratio of 15 percent and a total of non-mortgage debts at $437.50 or less each month.

Tier 2 – 15 to 20 Percent

The next tier is a debt-to-income ratio of 15 to 20 percent. Using our previous reference, if weare earning $35,000 annually, a debt-to-income ratio of 20 percent equates to a monthly debt costs $583.40. This cost can still keep consumers way above the waters.

Consumers will want to delve on a self-pay method (i.e. the debt ladder or debt snowball) and try to be disciplined as much as possible to stay on top of their debts.

Some consumers, however, will begin to struggle at this level. The question is: why the debt-to-income ratio is starting to slip at this point.

Tier 3 – 20 Percent and Above

The last and the most dangerous is the tier of 20 percent.

At $35,000 income, a 25 percent debt-to-income ratio is equivalent to a monthly debt of $729.25! Obviously, that’s a clear sign something bad is brewing up.

This ratio means we have more debt than what we can really afford and this is going to be tough.

How about mortgages?

Mortgages are approached differently. The two terms related to mortgage and debt-to-income ratios that we should be familiar with are front-end and back-end.

The front-end ratio is the percentage of your income that is allotted to housing expenses. In determining the loan amount, the lender considers the gross income that’s multiplied by the required front-end ratio and arrive at a total amount. The total amount is the cost that you pay for housing. The loan that will be granted to you does not exceed the total amount.

The back-end ratio, otherwise, is a higher amount. This adds up housing expenses and all other debts you are paying, and the total should not exceed the loan amount.

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