You’ve probably heard (or read) me say this before… “you can’t manage what you don’t know”. When it comes to your living expenses, this is more important, and more relevant, than ever before. Knowing what you spend is not only smart to ensure you’re on top of your money management, but it is also necessary when it comes to borrowing money. Let me explain…
A while back I wrote a blog explaining how your borrowing capacity is calculated, and the variables which impact your borrowing power. One of the key variables is your living expenses. Nowadays, your living expenses has a much bigger impact that ever before.
Up until a couple of years back, your bank or lender would use a standardised monthly living expense amount – which was based on the number of persons in your household. The regulators saw a problem brewing as money was being lent hand over fist with little regard to individual affordability. Since then lenders have been more vigilant with their assessments to ensure money is being lent responsibly to people who can afford it. Affordability is individual and varies from person to person.
One of the biggest changes we’ve all experienced over the last couple of years is the focus and scrutiny around living expenses. The use of a standard amount was no longer logical as each household is different. What one person, one couple, or one family spends is completely different to the other. A good example I see in my daily work is that some clients send their kids to private school (which costs upwards of $20,000 per annum per child) versus others whose kids go to public school which costs just a few thousand dollars per annum.
These changes made a significant dent to the borrowing capacity amount – nowadays you are asked to list your living expenses in detail. This list is then verified against your bank statements to ensure what you disclose is a true reflection of what you are actually spending.
The main reason why higher living expenses squashes your borrowing power is that each dollar is based on after-tax dollars. One thing I have learnt over the years is that most Australians live on their gross and not on their net. Net is your take home pay, or profit if you’re in business, and this what matters most.
There are many other reasons why you should be on top of your living expenses and on top of your household cash flows, and not just when you want to borrow money.
Here are 7 good reasons I can think of right now:
- Plan for months when your outflows exceed your inflows thus ensuring you maintain a sufficient financial buffer
- Track your money performance to ensure you reach your financial goals faster
- Take the financial stress out of your life as you won’t be surprised when household bills arrive
- Gain a better understanding of your surplus cash which you can then invest into high growth assets, creating more long-term wealth
- Improve your chances to be approved for mortgage finance as your bank statements can be better managed to look good in the eyes of the lender when assessing your application
- Sleep well factor as there is nothing better than knowing you are totally across your cash flows and your cash position
- By knowing where your money is being spent you’ll take control of unnecessary or excessive expenses to help you stay on track with your money goals
I could go on all day, but the above are the main ones. As you can see, being in control of your money helps you in more ways than just when it comes to listing your living expenses for a mortgage application.
If you don’t have a handle on your cash flow and you don’t know where to start, here are my tips which may help:
- Print out your bank account (or transaction listing) for the last 12 months, including credit cards if you transact on credit card as well
- Make a list of various expense categories such as Shelter, Food, Transport, Household, Recreation, Education, Insurances, Medical, Clothing, Other
- Go through all your debits (from bank account or credit card) and select one of the above categories which each expense falls under
- Review your top 10 expenses and consider if they’re fixed or variable (example of a fixed expense is your council rates, and variable are usually discretionary expenses such as eating out)
- Consider opportunities where you could “trim” and what changes you could implement right away to improve your cash position (e.g. are you really making use of that gym membership?)
- Create a cash flow template for the next 12 months, phased by month, to set the scene for yourself for the next 12 months
- If your analysis reveals that there is surplus cash ongoing, look into investment opportunities to ensure you’re creating a more secure financial future for yourself
The formula to getting ahead financially is this – spend less than you earn, and invest the rest. Simple but not commonly found.
I hope my blog today gives you food for thought, or is a good reminder of what you already know.
Disclaimer: The Information is general in nature and does not take into account your particular investment objectives or financial situation. It does not constitute, and should not be relied on as, financial or investment advice or recommendations (expressed or implied) and is not an invitation to take up securities or other financial products or services. No decision should be made on the basis of the information without first seeking expert financial advice. Your full financial needs and requirements would need to be assessed prior to any offer or acceptance of a loan product. Subject to lenders terms and conditions, fees and charges and eligibility criteria apply.