Budgeting sometimes gets a negative reputation as a practice reserved for people who can’t manage their money when, in fact, not having a budget is likely to jeopardize your finances — and worse, your credit score — regardless of how good you think you are at managing your accounts. Few Americans, it seems, are good at keeping a budget in place, perhaps because they’re under the illusion that frequently checking their bank accounts online is good enough. A whopping 68 percent of respondents in a 2013 Gallup Poll revealed that they don’t put a budget together to track their income and expenditures, and only 30 percent said they have a long-term financial plan to lay out their savings and investment goals.
These are obviously not numbers to be proud of, but it’s never late to raise those percentages. If there’s one aspect of handling your personal finances that should take priority above everything else, it’s knowing how to set up a budget. The practice affects many facets of your financial well-being, including your credit, which is why GOBankingRates is including budgeting in its Credit Score Challenge.
Having No Budget Can Hurt Your Credit
A budget is the best way to track your income and your expenses so you can balance your spending and saving in the best ways possible. Budgets are like road maps: They are financial tools that help people set goals for the present, see what’s ahead for the future, and avoid financial pitfalls and potholes along the way. Without a budget, it’s hard to maintain awareness of where your money is going — and without a plan in place, you might be harming your credit without knowing it.
Common mistakes the budget-less consumer is prone to making include:
- Relying too much on credit. It’s a common scenario: Every monthly bill and daily expense gets charged to your credit card. Congratulations for paying off your balance in full and on time each statement period, but you’re still hurting your credit because the credit bureaus that track your behavior will see that your credit utilization ratio — how much credit you use in relation to your credit limit — is too high. Proper budgeting can ensure more balanced use of your credit cards and avoid damaging your FICO score.
- Forgetting those due dates. A proper budget outlines the exact dates your auto loan, mortgage or rent, credit card, utilities, cable, and other bills are due. Estimating those due dates and paying your creditors late is bad for your credit history. Missing them altogether is worse and completely avoidable with an itemized calendar of dates in your budget plan.
- Repeating mistakes — and paying a lot for them. If poor budgeting has led you to make the above mistakes, it can damage your credit score for years to come. Missed mortgage payments can lead to foreclosures or liens, and ignored auto loan payments can lead to repossessions. Unpaid credit cards can result in high-interest debt that can spiral out of control. “Existing credit doesn’t just cover accounts that are open now; it also includes past credit as far back as seven years,” according to Mint.com. “Public record shows bankruptcies within the past 10 years, judgments and liens.”
How to Build the Perfect Budget
Your budget reflects your circumstances, priorities and goals. “Don’t tell me what you value,” Vice President Joe Biden has said. “Show me your budget, and I’ll tell you what you value.” There’s great value in a personalized budget, and it can be modified or changed at any time to reflect how you want to modify your spending. Here are important steps in creating your budget to gain control over your finances and improve your credit score:
1. Establish important goals.
Start your budget by making a list of the financial goals you’d like to accomplish. Those goals could include saving for a house, college tuition or retirement (long-term goals), or setting a deadline to save for a vacation or pay down some debt (short-term goals). Cutting away at debt can make a positive difference on your credit score, with some financial diligence and time. According to Bank of America, short-term financial goals should take a year or less to achieve, while long-term goals might take years.
2. Itemize your expenses.
Jot down every single expenditure you had last month and their amounts. Consumer.gov recommends starting with bills: First, list expenses that remain fixed each month, such as rent; those that vary month to month, such as utilities; and those that are paid annually or semi-annually, such as car insurance. Then, write down smaller or revolving expenses, like gas, groceries, entertainment and dining, and medical co-pays. Save as many receipts as you can to keep track of the correct dollar figures.
Organizing your bills in this way can help you determine where to start saving money. You can put the money you save toward paying off debt balances that impact your credit.
3. Determine all your income sources.
Your income isn’t only your take-home pay. In his Guide to Budgeting, Dave Ramsey suggests compiling every source of possible income, such as your paycheck, freelance or part-time work, child support or other residual pay.
Exclude nothing from this list because it plays a part in your budget — and your credit. “The overarching rule is this: If you receive money during the month, write it in your income category,” writes Ramsey. “There’s really no such thing as ‘found money.’ If you take it in, you should write it down.”
Once you have a good understanding of your income sources, check your debt-to-income ratio. Monitoring this ratio can help you adjust your budget and pay down debt so that you can improve your credit score.
4. Subtract expenses from earnings.
The ideal amount you calculate when you subtract expenses from earnings should be a positive value. If the number is less than zero, according to Consumer.gov, you’re spending more money than you make. The same goes for being aware of what you’re putting on your credit cards and keeping track of your ongoing balances. Ignore these factors, and your FICO score may take a serious hit down the line.
5. Redesign your spending plan.
Allocate portions of your income each month to different expenses, and set spending limits so you don’t go over budget on some and under budget on others. Suggestions vary; some experts recommend allocating 35 percent of your budget for housing, 15 percent each for transportation and debt, and 10 percent for savings.
You might benefit from experimenting with the 50-30-20 approach:
- 50 percent on fixed-expense needs like monthly bills — including debt-related items such as credit cards and other loans
- 30 percent toward wants, such as gifts, entertainment and clothing
- 20 percent exclusively for savings and investments
6. Find ways to reduce your spending.
Ramsey calls habitual spending on luxuries that can eat up your budget “money gotchas.” “If you are spending more than you make each month, you have to start cutting stuff,” he writes. “Use coupons, sell items that you don’t need or have payments on, and stop going out to eat.” Other frugal alternatives include buying generic products instead of name brands or cooking at home.
You don’t need to eliminate every single luxury purchase from your budget. When you spend in moderation, living within your means becomes easier. Try cutting back on your credit card use and limit it to smaller purchases, which can help keep your debt low, your credit revolving, and for those with rewards cards, help earn points.
7. Take advantage of budgeting tools.
Prepare a spreadsheet to make budgeting and tracking your credit card use easier. You might prefer a paper budget worksheet or using a spreadsheet program such as Excel to outline your weekly and monthly budgeting plan. You also can try online and mobile budget-building tools available from Mint.com or Vertex42.com to ensure there are no errors in your calculations. Many apps and budget programs are free to download.
8. Stick with it.
There’s no way to prove your new budget’s impact on your credit score if you don’t stick to your budget consistently. Use your budget every month, track what you spend weekly and always monitor your credit usage.
To optimize your budget, you should spend an hour with it each week, according to MoneyCrashers. In time, you’ll be less reliant on credit, more timely with bill payments and more in control of your spending — enough so that you’ll have improved your financial discipline and your credit score.