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Don’t let money rules of thumb get you down | Personal finance

Don't let money rules of thumb get you down |  Personal finance

Kelsey Sheehy

Put 20% down when you buy a home. Do not spend more than 30% of your income on housing costs. Keep childcare expenses below 10% of your annual household income.

These money rules can be useful safety rails, helping you allocate expenses and determine what is affordable. They can also be incredibly defeated when they feel unattainable.

If money “rules” feel completely disconnected from your reality, know this: The average American doesn’t come close to hitting many of the popular money rules. And that’s right.

“If you treat ‘rules of thumb’ as rigid rules, you’re setting yourself up for frustration,” says William O’Donnell, president of Heartland Financial Solutions in Bellevue, Nebraska. “The thing people tend to forget is that guidelines are flexible because everyone’s situation is different.”

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What’s important is to control your spending and build a spending plan that works for you, not some ideal. Here’s how to see money rules of thumb in the context of your own personal financial reality.

The rule: Budget 50% for needs, 30% for needs, 20% for savings

The reality: Housing alone can eat up half of your take-home pay

The 50/30/20 rule is a popular budgeting framework that divides after-tax income into three buckets: wants, needs, and savings. But expenses you have to pay can destroy that budget before you’ve even started.

In 2020, for example, 23% of American renters spent half or more of their income on rent alone, according to the most recent data available from the US Census Bureau. Add in other needs—utilities, groceries, transportation, insurance, child care, and debt payments—and there is little, if anything, left for needs or savings.

Don’t scrap your budget if the buckets don’t work. Instead, embrace the principle and adjust the framework to fit your current financial situation, with an eye toward where you want to be in the long term. Sure, it might be more of an 85/10/5 budget right now, but over time you can move closer to your ideal balance.

Simply tracking all your expenses is a good start; you’ll see where every dollar goes and can make more informed decisions about your spending.

The rule: Limit childcare spending to 7% of your income

The reality: Most families spend 20% or more on childcare

The US Department of Health and Human Services considers spending more than 7% of your annual household income on child care unaffordable.

But a whopping 51% of parents spend more than 20%, according to a 2022 survey from Care.com, which interviewed more than 3,000 parents who pay for child care.

There are few things you can do to dramatically reduce childcare costs, but discounts and scholarships may be available depending on your state and childcare situation.

A flexible spending account for dependent care is another option. If your employer offers it, you can contribute up to $5,000 pretax and use the funds to help pay for a babysitter, daycare, after-school care and summer camp registration, among other things.

The rule: You need a 20% down payment to buy a home

The reality: First-time home buyers usually put about 7% down

The 20% down payment “rule” is an outdated one, says Jessica Lautz, vice president of demographics and behavioral insights at the National Association of Realtors.

“The typical first-time buyer only puts 6-7% down for a down payment,” says Lautz.

Yes, lenders once required such a sizable down payment, but they now rely on private mortgage insurance, or PMI, to mitigate their own risk and pass the cost on to lenders.

Homebuyers who put less than 20% down pay an average of 0.58% to 1.86% of the original loan amount per year for PMI, according to Genworth Mortgage Insurance, Ginnie Mae and the Urban Institute. This can add hundreds of dollars to your monthly mortgage payment.

Putting more money down up front lowers the monthly and overall cost of your mortgage, but emptying your savings to buy a home can leave you on shaky financial ground.

About 3 in 10 homeowners (29%) no longer felt financially secure after buying their current home, according to a 2020 survey conducted by The Harris Poll for NerdWallet. That feeling was sharpest among younger homeowners, with 42% of millennials and 54% of Generation Z homeowners feeling financially insecure after buying their home, compared to 31% of Generation X and 16% of baby boomer homeowners.

A mortgage broker can use the numbers to help you determine the sweet spot for your down payment, but you should also ask yourself some questions, Lautz says.

“Do you need money in savings to rebuild once you’re in the house, or backup savings for other expenses?” she says. “Would a lower monthly mortgage payment be easier on other monthly expenses like student debt or child care?”

This article was written by NerdWallet and was originally published by The Associated Press.

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