How to use your budget

When all of your expenses are sorted and labeled, what next? The categories themselves won't tell you everything you need to know to cut spending. You'll probably know right away which categories could stand a little trimming. But if you need a little guidance, a helpful tool is a spending ratio.

Spending ratios

A spending ratio compares your total income to how much you use for a certain expense. For example, say the gross income that you earned last year was $50,000. In your budget you find the fixed expense of housing, and see that you paid $18,000 in rent or mortgage bills last year, or $1,500 a month.

You realize you can't just stop paying since housing is an essential expense. But, your spending ratio for last year was $18,000 to your $50,000 income, or 36%, and you may want to reduce it.

So what do you do? You might be able move to a less expensive apartment or a smaller house. If you are able to reduce your rent by a third, your spending ratio would decrease to $12,000 of your $50,000 income, or 24%, which you decide is a much more manageable number for your particular situation. That frees up $6,000 a year in your budget that can be used for other things, like saving toward retirement.

But if your home is in a neighborhood with a great local school system, is close to your work and health care providers, or you simply love it, you might want to budget for the higher housing costs and cut back in other areas instead.