by Pavlos Loizou
CEO of WiRE
Rising prices have been a major topic of discussion over the past few weeks. In essence, however, little can be done by individuals to mitigate the effects of rising fuel and commodity prices on a global scale. Nevertheless, it constitutes a good opportunity to recall some simple and basic rules that should be applied by all households, be it in times of high inflation or in times when prices are at lower levels.
Τhe (often forgotten) general rule that everyone should follow, is that we must not spend more than we earn. Whether this is being implemented by the majority of households will be seen in practice in a few years, although we are concerned that low-interest rates and government subsidies may have pushed many to take on loan obligations, which they may at some point, be unable to meet. The current situation is a great example: the cost of living is increasing and with it, the financial pressure on an average household.
That is why this article aims to be just a… kind reminder of the 28/36 rule. A very simple rule that helps us calculate the impact that lending can have on your household’s financial situation. In particular, the number 28 refers to the amount of your income (percentage-wise) that you can spend on your home, in other words, you should not spend more than 28% of your gross income on housing-related expenses. These expenses may include a mortgage, home insurance and property tax. For those who rent a property, it concerns all the expenses related to the property in which they live.
The number 36 refers to the percentage of your gross household income (36%) that you can spend on borrowing-related expenses. That is, expenses that in addition to a housing loan may include a car loan, or credit cards or even the purchase of some goods and products in monthly installments—an increasing consumer trend, lately. For example, if the annual gross family income is €40,000 then your housing costs should not exceed €11,200 or €933.30 per month. Accordingly, your annual borrowing-related liabilities should not exceed €14,400.
We do not need to delve into the reasons why all households should exercise prudent financial management. During the last few years, we have all been witnesses to the situation with non-performing loans, the accompanying loan sales and the high private debt which is currently impeding economic growth.
Be that as it may, we are all witnessing increases in fuel and basic consumer goods. If, for example, the fixed expenses of a household have increased by 10% -15% during this period, then those who did not comply with the rule of 28/36 will face problems and find it difficult to meet their financial obligations as their finances will be stretched even further. If price increases continue in the long run, including interest rates rising on existing loan facilities, which it now has, then the situation will become even more troublesome.
That is why prudent financial management is always necessary. Even more so during the good times, since that is when the necessary “stock” is created to take us through the hard times. And there will always be difficult economic periods, either because economic cycles are coming to an end or because unexpected events occur.