Financial health is the state and stability of one’s personal monetary affairs. It involves many financial dimensions, such as money spent on fixed or non-discretionary expenses and funds put away for savings, retirement, and emergency.
Having robust financial health means being financially resilient. It allows you to cover daily basic needs and unexpected costs, even if you experience a loss of income. Unfortunately, however, it’s far less common than it should be. Recent research shows that 63% of Americans live paycheck to paycheck as of September 2022. This financial situation eats away at limited income and damages credit.
To avoid bad financial conditions, the following five factors should be taken into consideration.
Credit scores measure financial stability and credit management, so having a good score always translates to having good financial health. A strong credit standing also means you can enjoy more financial advantages, such as higher credit limits, favorable interest rates, premium credit cards, a credit limit increase, and more purchasing and negotiating power.
A good credit score depends on the credit-scoring models. For example, based on the FICO® Score, a credit score of 670 to 739 is good. Alternatively, based on the VantageScore® range, the good range is between 661 and 780.
Between these two models, lenders most widely use FICO scores. Here are the factors that determine FICO scores and what you need to improve them:
- Payment history (35%). Pay all bills on time.
- Amounts Owed (30%). Make progress in paying off debt.
- Credit history length (15%). Keep old accounts open unless needed.
- Credit mix (10%). Have a mix of installment accounts with equal payments.
- New credit (10%). Avoid applications requiring a hard inquiry on your credit.
One’s credit usage is based on their debt-to-income (DTI) ratio. It’s the total monthly debt payments, such as rent, mortgage, credit cards, or other debt, divided by how much money you make a month (before taxes).
Simply put, this is how you calculate a DTI ratio:
DTI % = Gross Monthly Debt Payments ÷ Gross Monthly Income
Ideally, you want to achieve a low DTI ratio. It indicates an even distribution between debt and income, which shows great debt health. To lower your DTI, consider the following ways:
- Pay down high balances;
- Lower interest on debt;
- Avoid using credit cards impulsively;
- Implement a 24-Hour Rule (Wait for a day before making a big financial decision); and
- Do a side hustle.
An emergency fund is any cash or highly liquid asset stashed to cover unexpected costs. Setting it aside to get through any financial distress is another way to make your financial condition healthy.
It’s recommended to save around three to six months’ worth of your gross monthly costs as your emergency fund. Additionally, for an added financial cushion, consider setting aside your tax refund for your emergency funds instead of spending it.
Save your emergency fund in a separate savings account and have it deposited automatically to avoid spending it for another purpose. To gain interest-earning potential, save it in money market accounts, such as high-interest savings accounts and no-penalty certificates of deposit (CDs) that don’t charge early withdrawal penalties.
A retirement plan helps in fulfilling your wishes while maintaining your financial independence. As its name implies, it’ll help you secure a regular flow of income after retirement, making your finances healthy during your golden years. Moreover, having a retirement plan gives you more credit options and a better credit score.
In preparing for your retirement plan, saving at least 10% to 15% of your pre-tax income every month is recommended. Nonetheless, it’s crucial to know that it’ll be financially hard to pay large amounts of bills or debt off, even with a retirement plan. Retirement is only financially ideal once your financial situation is stabilized.
Insurance plans are your financial safety net. In other words, being insured before an unexpected event happens means avoiding raiding your savings, asking loved ones for financial help, borrowing money, or selling assets to pay for repair costs or outstanding debts.
In addition to financial security, an insurance plan is like a two-for-one investment. After a certain period, some parts of the premiums will become investments. They tend to grow as the value of your premiums increases.
Invest in several insurance plans, such as life, health, home, auto, and insurance, depending on what’s important to you. The more financial backups, the better. It’s always beneficial to be extra careful than to be regretful later.
In a nutshell, one’s financial health is conditioned by good credit scores, low DTI ratios, enough emergency funds, retirement plans, and insurance coverages. Always remember to pay debts on time, prioritize needs over wants, stick to your budget, get insured, and save now, not later.