How to build a more effective budget

By UK CreditCards.com

Most people have their own idea of how to budget. But many aren't doing it properly. Here's a step-by-step guide to building a more effective budget so that you can live better on less.

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Step One: Calculate how much you're spending on essentials.
The biggest expenses for most households include mortgage repayments or rent, transportation and food. These three things can easily add up to at least half of your income or more, leaving little room for other expenses.

In order to determine how much you're actually spending on essential items, total your fixed expenses, such as loan payments. Then estimate how much you spent on food and petrol in the last year. 

Step Two: Compare your monthly commitments to your income.
In this difficult financial time, families are trying to cut back where possible, perhaps by getting rid of the gym membership that never gets used or by buying own-brand supermarket goods instead of expensive alternatives.

However, if your minimum monthly payments for your housing and other commitments are close to your monthly take-home pay, you could cut back on absolutely everything and still be in financial difficulty.

That's why it's essential that you determine exactly how much of your income you're using on monthly essentials. You may find that you're spending more on your commitments than you can afford. For example, if you spend 50% of your income on your housing, 20% of your income on your car or other transport and 10% of your income on your debt repayments, such as loans and credit cards, you will only have 20% left for everything else. That "everything else" includes essentials, such as food and petrol, as well as expenses such as socialising, insurance, pension and savings.

Step Three: Rethink how much of your income you spend on essentials. 
For most people, the main essential outlay is the home, and an early wrong decision on this could upset the rest of your budget and ultimately your financial future, say experts. There has been plenty of discussion over the years as to what percentage of your monthly income should be spent on housing. (Your total costs for housing includes anything related to the daily running of your home, such as rent/mortgage, council tax, energy, telephone and other utilities.)

However, many experts recommend that your housing costs should not exceed 30% to 40% of your income. Therefore, if your take-home net monthly pay is £1,000, you should spend no more than a maximum of £400 on your housing. If you're spending more than this amount, then you may need to reevaluate whether you can afford your current home.

Also review how much you're spending on food, petrol and other essential items and consider whether your current levels of spending are sustainable. If they're not, then you will need to rethink how much of your monthly income you allot to these items.

Step Four: Look for ways to increase your income or reduce your monthly outgoings.
The most important aspect of money management is a simple one: Establish that you have enough money coming in to cover your bare minimum of outgoings. If you don't, then you need to either increase your income or reduce your outgoings.

Actions that are aimed at reducing your monthly outgoings can be relatively small, such as cutting back on the amount of gas and electricity you consume. Or they may need to be far more dramatic, such as refinancing your car or moving to a smaller and less expensive property.

If, after this time, you still don't have enough spare cash, you will need to think more expansively about how you can increase your monthly income. Rather than use additional credit to fill in the gaps, some experts recommend that you take on part-time work instead. You can also use this extra money to pay more than the minimum amount due on high interest loans, such as credit cards, and pay down your debt more quickly. 

Step Five: Switch to a prepaid card for your non-essential spending. 
If you tend to overspend on extras such as clothing or socialising, you may want to designate a prepaid card to pay for your "everything else" pot. You can load the remaining cash you have available after paying for your monthly essentials and use the prepaid card to make all non-essential transactions. This will prevent you from overspending and ensure that you stay on track with managing your money.

If, at the end of the month, you still have spare cash left over on your card, you can then use that money to pay down debts such as credit cards, overdrafts and loans and save even more in the long run.

Step Six: Think twice before you sign another contract.
Once you commit to something in a contract, it can be incredibly difficult, not to mention, expensive to get out of it. Before you sign anything else that ties you in for the long term, make sure that you determine ahead of time whether you can afford the monthly payments.

Leave ample room in your calculations for unexpected expenses, such as rising food prices and sudden emergencies, and research whether you can find a similar service or product for a lower price.  

See related: 4 tips for shopping online without breaking your budget; Average Brit saves £1,196 a year with vouchers

Published: 6 September 2011