The Basics of Financial Responsibility
What does it mean to be financially responsible? It’s a complex question with a complex answer, but at its core is a simple truth: to be financially responsible, you need to live within your means. And to live within your means, you must spend less than you make!
Credit Cards and Debt
Sorry – if you’re really looking to be financially responsible, just being able to make your credit card payment doesn’t cut it. In fact, the fact that you have a credit card payment at all and aren’t able to pay your balance in full shows that you already spend more than you earn. Responsible use of a credit means paying the balance on your account in full each month.
And (this part will hurt) credit cards should be used for convenience, not to make ends meet. Credit cards are handy because they eliminate the need to carry cash – you can even generate reward points. And credit cards can be very helpful in an emergency. That said, if an emergency does force you to carry a balance on your card, living in a financially responsible manner means curbing your spending until that balance is paid off.
The same logic applies to all recurring payments that involve paying interest. Think about: paying interest on anything means that you are spending more for that item than the purchase price. Does that sound like the most responsible choice, or just the most convenient? When the interest payments are factored in to the purchase price, you are spending more to obtain the item than even the item’s manufacturer thought it was worth. As such, avoiding paying interest on anything should be a major objective. Of course, when it comes to the cost of housing and transportation, avoiding interest is almost impossible for most of us. In such situations, minimizing the amount you spend in interest each month is the most responsible action.
Acting in Your Own Best Interest
For many people, cutting down on interest and borrowing is easier said than done, but in practice, it really comes down to knowing the difference between necessities and luxuries. For example, you might need a car, but you don’t need a luxury sedan and, unless you can afford to pay for it in cash, you shouldn’t be driving one. Likewise, you might need a place to live, but you don’t need a mansion. And, although most of us must have a mortgage in order to afford a home, purchasing a home in a financially responsible manner means that you should purchase one that won’t break the bank. In financial terms, this means it shouldn’t cost more than two or 2.5- times your yearly income. Another healthy estimate is that your monthly mortgage payment should not cost more than 30% of your monthly take-home pay.
In addition to avoiding overspending on your home purchase, you should make a down payment that is large enough to eliminate the requirement of having to pay for private mortgage insurance (PMI). If you can’t afford to meet these purchasing guidelines, rent until you can afford to buy.
Paying Yourself First
Spending every dime that you earn is simply irresponsible unless you have a massive trust fund that is so flush with cash that you will never outlive the earnings. For most people, especially those of us hoping to retire someday, saving is an activity that must be taken seriously. A great way to do this is when you get your paycheck – and before you pay your bills – pay yourself first. A good goal to save is 10%.
Financial responsibility means being prepared for the unexpected. Most experts agree that you need to be able to support yourself financially for at least six months without an income. If you are married and used to living on dual paychecks, this means being able to pay the necessary bills such as the mortgage, food and utilities on one income – or even neither income. If a missed paycheck would ruin you financially, it’s time to create a financial escape hatch to prevent this.