Mastering your Personal Finances
This is a comprehensive guide to mastering you finance through manging your household budget.
In this new guide you’ll learn how master you houshold budget
Let’s dive right in:
The way we encourage our clients to think about their personal finances is to liken it to running a business. All successful businesses manage their budgets carefully, ensuring that income generated always exceeds expenditure. It’s essential to be successful as a business, and its essential to be successful in managing your finances.
This can also help prepare for a mortgage, you will have have a tight control over your finances. Essentially this means spending less than you earn, not generating debt and managing your financial risks so you’re protected in the future. In this guide we give an overview of how to prepare a monthly budget and stick to it.
Why bother taking this approach? Well, mortgage lenders want to know that you’re able to live within your means and are not going to be a financial risk to them. They see evidence of this in your credit history and bank statements. If you have substantial debt which is not being paid off, or missed credit card payments on your credit history, they may not accept you for a loan.
Sound financial management like this can help you improve your credit score, pay off debts and save for a deposit.
How to prepare for a mortgage by managing your monthly budget
Step 1. Assess your monthly income
Start by assessing exactly what you have coming in each month, after tax and deductions like employer’s pension. If your wage varies, then an average of the last 6 months’ wage slips is a good starting point. This calculator is helpful if you know your annual salary, but it varies month to month and you wish to work out you monthly net income after tax.
If you’re self-employed, use a conservative monthly income figure to cover yourself for lean months and unexpected business costs.
Step 1. Assess your fixed monthly outgoings
The next step is to go through your last 3 months bank statements and make a note of all your fixed monthly outgoings. We’ve made an excel file to help you with this (LINK). Here’s a typical example:
|Mortgage or Rent||£650|
|Gas & Electric||£100|
|TV Package & Licence||£82.12|
|Loans & Finance||£100|
|Credit Card Payments||£39|
|Break down cover||£12.5|
|Netflix or other subscription||£6.99|
Step 2. Assess your variable outgoings
Now it’s time to assess your variable outgoings – expenditure that fluctuates from month to month. These will include groceries, entertainment, eating out, transport, lifestyle, health, shopping and clothes.
Here’s a typical example:
|Entertainment Nights Out||£197|
|Shopping Clothes etc||£100|
You might find it difficult to assess or keep track of these costs, as they’re so changeable. In addition, this sort of expenditure is often paid for with debit cards, which complicates your bank account with lots of smaller transactions.
With this in mind we recommend using an entirely separate bank account for this sort of daily variable spending. This will enable you to track and assess your expenditure more easily. Some of the new app-based bank accounts like Monzo and Starling are very useful, because they enable you to categorise your transactions, which helps the process.
Once you have an idea of how much you’re spending on variable outgoings over the course of a month, you can then create a daily and monthly budget. The idea is to transfer the monthly budget amount into your app-based current account once per month, and to try and stick to it.
After a few months you’ll have a good idea of what you’re spending day to day, and you can vary it as required.
Step 4. Cut back on non-essential outgoings, and ‘snowball’ to pay off debt
Now that you’ve worked out where your money is going, spend some time looking at what spending is essential, and what you could do without.
As an example, let’s say John, an IT professional, has a gross annual salary of £30,000. This gives him a net figure of £1994 going in to his bank account every month, after tax. He also has £1200 on an overdraft and a credit card with £800 debt on it.
John spends £1395.61 on fixed monthly outgoings, and £669 on variable day-to-day spending. This month he spends £2064.61, which is an overspend of £70.61 against his income.
The first John should do is look at his spending and work out an ideal outgoings budget.
|All fixed outgoings|
|Mortgage or Rent||£650|
|Gas & Electric||£100|
|TV Package & Licence||£12.12|
|Loans & Finance||0|
|Credit Card Payments||0|
|Break down cover||£12.5|
& Nights out
|Lifestyle & Health||£65|
|Shopping Clothes etc||£75|
This new budget leaves a monthly surplus of £464. John plans to reduce his outgoings by:
Getting a cheaper TV package.
Getting a cheaper sim-only mobile contract.
Paying off debts.
Stopping using his overdraft.
Reducing day-to-day spending.
Getting there won’t be easy for John, as part of the plan involves paying down his debt in order to free up a surplus every month. So, he takes it step by step. Cancelling the TV package and reducing day-to-day spending frees up £299, and he uses this to pay off debts quite quickly. He also decides to temporarily cancel his Netflix and gym subscriptions to speed up the debt repayment. This method is called ‘snowballing’. Within 5 months, John has paid off his debt and also generated a surplus amount of income every month.
Step 5. Save surplus income every month to create an emergency fund
Let’s assume you have also reduced your monthly fixed outgoings as much as possible, and got a handle on your day-to-day spending. Each month you receive a salary after tax. You transfer £450 per month to the app-based account, for your day-to-day spending. You leave £1100 in the current account for your fixed monthly outgoings. You should then transfer the £450 that is left over to an easy-access savings account.
You should ideally save in this way until you reach a point where you have 3 months’ worth of outgoings, both fixed outgoings and day-to-day expenditure. So that would be (£1100 + £450) x 3 months = £4650. This money can then be used as an emergency, for when you experience large unexpected costs. This will stop you accruing unexpected debt in the future.
Hey presto! Just like a well-run business, you now have a healthy monthly budget and a good reserve.
Some personal finance experts suggest you save up for this emergency before you start paying off debts. All of this depends on how much free cash you can generate in your initial budget session.
Step 6. Start investing
Now you have an emergency fund saved, and are living within your means, you are now in a much better position to start looking at other savings options, for example, ISA allowances, saving for a buy to let, etc.
One thing that also needs to be considered in your household budget is managing your risk of being unable to work through accident or sickness. As without a protected monthly income, this entire process does not work. So, in the next article we will look at that.
Next article – How to prepare for a mortgage: 2. managing future financial risks (LINK)
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