Your financial health is important. You go to the doctor for your physical health. So why not check your financial health? Understanding your financial situation can help you make smarter financial decisions. With a strong grasp of your finances you can figure out if you can afford to send your kids to summer camp. Or you can see if you can afford to take that vacation you’ve been dreaming about.
Your financial health can also help you get prepared for emergencies. Above all, knowing how to improve your financial health builds confidence in your decision making. In the following updated article, we’ll walk through how to get an idea for how you’re doing financially. We’ll talk about income levels, stressors, and preparedness at all stages of life.
When Should I Check My Finances?
Everyone should have an idea of where they stand financially, no matter how old they are. Freelancers, newlyweds, and even grandparents can all benefit from checking their financial health. Knowing and understanding your financial position helps you plan for both now and the future. As a benchmark, you should check in on your finances at least once or twice a year.
Do You Have a Budget?
A budget is one of the most telling signs of a financially healthy person. Having a budget means you have a clear picture of where your money goes. It also outlines how you plan to achieve your financial goals. Your budget includes savings, paying down debt, insurance, and your everyday lifestyle. It also helps you compare to others in common spending categories.
If you don’t have a budget, two of the most popular budgeting types are the 50-30-20 budget and the zero-based budget. It’s easy to create your first budget. Don’t worry if the numbers aren’t perfect in your first budget! The important thing is that you have a general idea of where your money is going. Not getting it to zero.
Steps to Determine Your Financial Health
We’ll walk through this financial health assessment in parts. To begin with, you’ll gather basic information about your finances. You’ll then use these numbers to figure out your debt to income ratio and then how to put it all together to gauge your financial health. If you already use a budget, this first part should be relatively easy.
Step One: How’s Your Income?
Start by looking at your take home pay. This is the total amount of your paycheck after taxes and deductions are taken out. It does not include how much you’re contributing to retirement. If retirement savings or insurance are getting taken out of your paycheck, add them back in. You can find your total take-home pay by looking at your pay stub. It will detail your gross pay minus state and federal taxes and FICA.
Action item: Learn and understand your total gross income – this is your pay before any taxes or deductions. You can use this amount to assess how well you’re earning compared to peers in your industry.
Step Three: Your Housing Situation
Housing is likely the biggest part of your budget. Where you live can put a lot of strain on an otherwise balanced budget. Hotspots like San Francisco aren’t the only places where rent or mortgages are expensive though. Even regular metropolitan cities like Orlando or Saint Louis report soaring rent prices. This makes economic security hard.
As a rule of thumb, your housing costs should be about one third of your total expenses. This can be hard to achieve if you live in a city or booming metropolitan area. But if your housing expenses are dominating your budget, it may be time to look at moving. Finding roommates, moving to the suburbs, or choosing a cheaper city won’t happen overnight. But having an honest conversation about your housing costs can go a long way for improving your finances.
Step Four: Your Emergency Fund
We’ve already covered the importance of having an emergency fund above. In short, an emergency fund is what protects you and your family in case of an emergency. Instead of turning to credit cards or short term loans, an emergency fund is there to keep you on your feet. The size of your emergency fund determines how big of a buffer you have in your financial journey. A sudden job loss or accident could deplete your savings quickly. Working to save money for a rainy day is part of staying financially healthy.
How Healthy Is Your Emergency Fund?
Do you have an emergency fund? If not, start by saving $1,000. Then work to save between 3 and 6 months worth of income. Check out our full guide on creating and maintaining and emergency fund.
Step Five: What’s Your Credit Score?
Next, let’s look at your credit score. Your credit score represents your credit worthiness. It’s a number between 300 and 850. Three credit bureaus in the United States track your borrowing and payment history. Everything from credit cards to mortgage payments affect your score. Your credit score updates every month automatically. You may be able to see your credit score for free through your credit card company.
Action item: Request a copy of your free credit report from freecreditreport.com. It’s important to not only identify your credit score but also what is affecting your score. And don’t forget to review it for accuracy. If possible, check with your credit card company to see if you can get access to your score for free.
It’s also important to check it for new lines of credit you don’t own. Make sure your payment history is accurate to how you’re actually paying your bills. While it may seem trivial, errors on your credit report can have huge impacts on your borrowing power. It can tarnish your financial reputation for years to come.
Step Six: What Does Your Debt Look Like?
Debt is one of the biggest factors affecting your financial health. Take the time to document all your outstanding debt obligations. Create a spreadsheet and write down all the debts you have. This includes mortgage balance, your car, credit card debt, student loans, medical debt, or any personal loans you have. If you do this, separate your debts into fixed debt and revolving debt. Fixed debt means the interest rate doesn’t change. Things like your mortgage, car payment, or personal loans are fixed debt. You can pay them at the same rate each month over a certain period of time.
Revolving debt is more volatile. Credit cards give you a credit limit and you’re free to spend as much or as little of that credit as you’d like. But in exchange for this flexibility, interest rates on revolving debt are higher. They may also change with very little warning.The danger with revolving debt is that if you struggle to pay back the balance in full each month, you can mess up your finances.
Making minimum monthly payments on your credit card or short-term loan racks up interest quickly. If you don’t have a clear plan of how to get out of this type of debt, it can follow you for years. Penalties, fees, and interest payments balloon. They end up costing significantly more than the borrowed amount.
Step Seven: Do You Have Insurance?
Insurance isn’t just for your health. Health insurance is obviously important. But depending on where you are in life, other types of insurance can protect your income stream and your family. These include life insurance and accident and disability insurance. If you pass away or can no longer work, these types of insurance will protect your income stream.
Life insurance policies provide payments to your family when you pass away. They can either be lump-sum payments or paid in monthly installments. Often, life insurance policies for younger people can cost just a few dollars per month. As you get older, these policies increase in price.
Similarly, accident and disability insurances cover expenses related to not being able to work. These are rarely covered by your employer. Accident insurance can cover medical expenses and make up for lost wages as you recover. Disability insurance pays out if you’re unable to go back to work at all. Plans differ between providers. But adding coverage for the unexpected to your insurance costs can save you and your family from financial ruin. As a good rule of thumb, disability insurance should cover at least 65% of your current income.
Action item: Price out life insurance, accident insurance, and disability insurance. This life insurance calculator will help you determine your life insurance needs. Even if you don’t purchase them yet, it’s good to plan for them as budget items.
Step Eight: How’s Your Retirement Readiness?
The last number you’ll need for your financial health assessment is your retirement savings. This could be through a retirement plan at work or through a personal investment account. Saving for retirement can never come too early. In fact, many Americans aren’t saving enough for their retirement. Don’t just check your retirement account balances. Those fluctuate. Instead, look at how much you contribute each month.
Step Nine: What’s Your Debt to Income Ratio?
Your debt to income ratio (DTI) is another good metric of how you’re doing. Paying a lot each month for debt isn’t a healthy place to be.
Your debt to income ratio is your debt divided by your monthly gross take-home pay.
Example: if you earn $50,000 per year, your monthly take home gross pay is $4,166 ($50,000 divided by 12).
Then assume your car payment, student loans, credit cards, and mortgage add up to $3,100 per month.
Next, divide your debt by your gross pay. $3,100 divided by $4,166 is 0.74, or 74%. This is your debt to income ratio.
Most debtors like to see a DTI ratio less than 30%. If you’re creeping up beyond that, it’s time to take a serious look at your finances.
Action item: If your debt to income ratio is high, take a hard look at your bills. Could you get a cheaper car? Reduce your student loan payments through deferments? Can you transfer your credit card balance to a lower interest rate?
Pulling it All Together
If you were able to complete all of the above steps, how would you rate your financial health? Are you on death’s doorstep? Surviving? Or are you in control of your finances?
Checking in on your finances is important. And it isn’t something you do once and forget about it. By checking your financial health once or twice every year, you can make sure you’re on track. No matter what stage of life you’re in, there are good benchmarks of debt, income, and financial goals.
Take baby steps to improving each category in your financial health. Whether it’s starting a budget, finding new income sources, or improving your credit score, it’s never too soon to start thinking about your financial health.
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