Dear Liz: I’m 28 and trying to get better with money. I’m enrolled in a debt management plan through a consumer credit counseling service and have paid $21,000 in credit card debt down to $8,000. The debt was left over from my divorce three years ago — my ex is nowhere to be found, so it’s all on me to pay it off, which should be done by early 2013. The biggest chunk of my paycheck goes to this debt and rent. Otherwise I don’t spend much. I use coupons for groceries and anything else I need. My car payment is reasonable (less than $200 a month) and my student loans are in forbearance. I spend less than $50 a week on food. I don’t have cable, only Internet and Netflix. I cut my cellphone bill to a manageable rate. I’ve switched car insurance companies several times to get lower rates. I usually bring my lunch to work and rarely buy clothes, eat out, get haircuts, travel, give gifts or do anything extra because I don’t have the cash at the end of the month. I went from paying everything late to paying everything on time. This is a great achievement for me. But all of this cutting back hasn’t helped. I still don’t have any money in savings and very little in checking. I transfer money into a savings account but then take it right out when it’s needed. And it’s always needed. I’ve been trying to find a second job or even a new job that pays more, but I feel like it’s impossible right now. Do you have any advice that could help me?
Answer: What you’re experiencing is frugal fatigue. You’ve cut and you’ve cut, but you still have a long way to go. It’s easy to look at the road ahead and feel discouraged.
But you have to give yourself credit for paying off $13,000 in debt. That’s a huge achievement. Give yourself another pat on the back for staying current with your bills.
The discipline you’re learning will help you enormously in the years to come. You’ll be able to build a substantial emergency fund once the debt is paid off simply by redirecting a portion of the money you’re now sending to creditors.
In the meantime, don’t sweat the fact that you don’t have a huge savings account. Work on setting aside just $500 or so, which should cover most small setbacks and keep you from having to use your credit cards. If you have to drain your savings for an emergency, that’s OK — the fund is serving its purpose. Just build it back up again.
Earning more money is usually the fastest way to dig yourself out of a hole. If you can’t find another job or a better job, create your own job. Perhaps your work skills lend themselves to moonlighting. If your job allows you to take on freelance clients, that’s a good way to bring in extra money. Otherwise, if you have a talent or skill you can teach, do that. If you don’t, consider providing services that others need: house cleaning, house sitting, dog walking, errand running.
You can look for some ways to give yourself more breathing room. If you’ve cut all the small expenses, then it’s time to look at the big ones: your rent and your debt payment. You may be able to free up more money for saving, and for living, if you find a roommate. Also, ask your credit counseling agency about the possibility of reducing your payments a bit. It will take longer to pay off your debt but it could make life more pleasant in the meantime.
Dear Liz: Do you have any advice for a family of six with only $200 a month to spend on food? My wife and I are in dire need of advice, as our bills keep increasing but neither of us has gotten a raise in six years. We have two garnishments on our paychecks that effectively take 50% of what we make. After health insurance and 401(k) loans are deducted, we bring home $2,000 a month. Our rent takes $1,400 of that and utilities take most of the rest. Do you have any miracle advice for us?
Answer: Many families are facing your dilemma: flat incomes with rising costs. But your wage garnishments and 401(k) loans indicate you have a history of mismanaging your money, which has led to even more pain.
You need the advice of an experienced bankruptcy attorney. Wage garnishments by federal law aren’t supposed to exceed 25% of your disposable income, and state laws often provide even lower limits. If you can get your garnishments adjusted or have them wiped out in a bankruptcy filing, you may be able to create more breathing room.
In the meantime, see whether you qualify for the federal government’s Supplemental Nutrition Assistance Program (formerly known as food stamps). If you make too much money or have too much in assets to qualify, you can still visit a food bank to supplement what you’re able to buy.
If you can’t find a way to lower your costs further, the only solution is more income — not an easy prospect given the high unemployment rate, but you may be able to find a job at a competing business that pays more or start a business on the side.
Unfortunately, there are no miracles when it comes to money math. You can’t make two plus two equal five or have outgo that exceeds your income without eventual disaster.
Dear Liz: It’s still not clear to me how I should prioritize saving for retirement, paying down (massive) student loan debt and buying or building a modest house, even though I have read a number of your articles and answers to many other readers’ questions. Once I pay off what is left of my credit card debt and build up an emergency fund, what then? Do I put retirement first, paying down student loans second and a modest house last? Or should I pay my student loans last — for instance, by opting for an income-based repayment rather than the higher, regular payment amount and going for the house instead?
Answer: You should put retirement saving first now, even before you pay off your debt. If you don’t get a relatively early start putting away money for retirement you’re unlikely to be able to catch up later. Those who start saving after age 35 have a very tough time putting away enough money to comfortably retire, says Roger Ibbotson, founder of Ibbotson Associates financial research firm and a Yale School of Management professor. The ideal time to start saving for retirement is with your first job.
Prioritizing retirement means you’ll have less money for other goals, so paying down your debt and building up an emergency fund will take longer, but so be it. The amount of extra interest you pay on your debt will be overshadowed by the tax breaks and investment gains you’ll make in the long run in your retirement accounts.
After paying off your credit card debt, your next goals will depend on your individual situation. If all your education debt is federal student loans rather than private loans, then you needn’t be in a rush to pay it off. That’s because federal student loans have relatively low, fixed rates and many flexible repayment options. You also may qualify for student loan forgiveness in 10 years if you work in public service or 25 years if you don’t. An income-based repayment plan would allow you to minimize your payments so you could put money toward other goals. You can research your repayment options at FinAid.org, a financial aid and student loan education site.
If, on the other hand, you have some private student loans, you’ll probably want to make paying that off a priority since the rates are variable and you don’t have as many repayment options. (You probably wouldn’t be able to make income-based payments, for example.)
When to prioritize a home purchase depends, again, on your individual situation. If you’re sure you’re where you want to be for the next 10 years or so and are eager to own a home, you could start a down payment fund as soon as you finish paying off the credit card debt.
Dear Liz: In the last two years, many of my friends and former co-workers have been forced to attempt self-employment, independent contracting, freelancing, etc. None of them had any previous experience working for themselves, and none had personal acquaintances who could provide guidance. Not surprisingly, although many have good business and interpersonal skills, none have yet had success.
Please advise of any websites, books, associations or other resources that suggest what pitfalls to avoid (taxes and benefits have been nightmares for many people I know), how to plan before taking the plunge into self-employment and how to maximize the chance of success.
Answer: An excellent place to start would be “The Money Book for Freelancers, Part-Timers, and the Self-Employed: The Only Personal Finance System for People With Not-So-Regular Jobs” by Joseph D’Agnese and Denise Kiernan, two freelancers who figured out through trial and error how to cope with the erratic incomes while trying to pay for their own benefits and keep the IRS happy. The authors’ system revolves around putting aside a percentage of all income toward these expenses, rather than trying to save specific dollar amounts, which can be tough on an unpredictable income.
Two other great sources include the Small Business Administration website at http://www.sba.gov and Entrepreneur magazine’s site, at http://www.entrepreneur.com.
Your friends also should look for professional groups that can provide networking opportunities with successful freelancers and entrepreneurs in their fields. Nothing beats one-on-one advice and mentoring from those who have figured out how to win the game.
Dear Liz: We’re a newly married couple with an 11-year-old and hope to have another baby soon. We have $20,000 in emergency savings, $40,000 in investments, $480,000 in retirement funds, $20,000 in low-interest student loans and $43,000 in high-interest credit card debt. If we have another child, we’d like for my wife to be able to stay home. I am struggling with how to prioritize debt reduction, college savings, home improvements and building our emergency fund. I don’t want to tap our savings or investments, as there are often surprises in life and I do not want to be caught short. The problem is that aggressively paying down the debt hurts our cash flow for our other goals.
Answer: It’s understandable that you don’t want to tap your savings or investments, since it’s difficult to build up those funds. But it really makes no sense to carry high-interest debt when the returns you’re getting on these other accounts are probably much lower.
Talk to your tax pro about the implications of selling some or all of your non-retirement investments, though. If your investments have gained substantially in value, you’ll want to factor in the tax bill or consider selling some of your money-losers instead.
Once the credit cards are paid off, some money that used to go to those payments will be freed up for other goals.
Your priority needs to be saving for retirement. Once you’re on track there, you probably should focus on rebuilding your emergency fund to equal at least three and preferably six months’ worth of expenses. You may not be able to accomplish that before your second child arrives, though, so consider opening a home equity line of credit as a proxy for a larger emergency fund. Leave the line of credit open and unused, however, because racking up a balance would defeat the purpose.
Saving for college is a worthy goal, although it shouldn’t take priority over retirement, paying off toxic debt or having an emergency fund. You may not be able to save enough to pay the whole bill, but you can shoot for saving one-third or half the expected cost, and your child can use federal student loans for the rest. SavingForCollege.com has a calculator to help fine-tune your plan. Even if you can’t save as much as you’d like, you should save something. Even $25 a month over time will help reduce the amount your child needs to borrow.
Home improvements should be last on your list of priorities, and you should try to pay for those with cash. They are not an investment in your home — although they may improve the value somewhat, you’ll typically get back less than 70% of what you spend.
Dear Liz: My cable and cell companies decided this month to hike their fees on me. Do I have any recourse? It’s not like I’m getting more service for their fees (that I know of) or am automatically getting a raise.
Answer: Cable and cell companies have competitors. Start by calling one of the satellite television providers and asking what specials it offers new subscribers. Then call your cable company and let it know you’re thinking of switching. Whatever the first offer is, hold off and see whether you can get a better deal. If not, switch or consider a life without pay television. Many popular shows are available free on the Internet, while others can be purchased as downloads. If you don’t watch much TV (and you’ve got lots of better things you should be doing, right?), you can save a lot of money.
Cell service can be a little trickier, particularly if you’re in the midst of a long-term contract. Consider using BillShrink or Validas (at http://www.myvalidas.com) to see whether you can get a better deal from your current carrier. If you’re not using all your minutes, text and data, your carrier typically will let you step down to a cheaper plan without extending your contract (check to make sure, of course).
If you’re not under contract, the world’s your oyster. Those two sites can help you search among the carriers to find the best fit for the way you use the phone. Or you could consider switching to a prepaid plan with no contract.
Dear Liz: My wife and I are about to sell our home and move in with her parents. We’ll have to drain our savings of $15,000 to pay off the rest of what we owe on the mortgage. After the sale, however, our reduced expenses mean we’ll have at least an extra $5,000 a month. We’re carrying roughly $20,000 in credit card debt and make $130,000 a year in income. I see this mortgage-free living as a great opportunity and don’t want to waste it. Can you recommend a good book or point us in a direction to ensure we capitalize on this interesting time in our lives?
Answer: That must have been one massive mortgage you were carrying. You may feel positively giddy once those payments are gone, but don’t let it go to your head.
It would be easy to ratchet up your spending now that there’s so much extra money in the bank, but resist the urge. Concentrate first on wiping out your credit card debt, then focus on building up your emergency savings. The discipline of paying off debt and building savings will help you learn to live within your means—something you obviously weren’t doing when you took on that home loan and built up credit card debt.
You also should be saving aggressively for retirement, if you aren’t already. Take advantage of any workplace retirement plans, contributing at least enough to get the full company match, and consider funding Roth IRAs for both of you. Roth contributions aren’t tax deductible but the money is tax-free in retirement, and you can contribute up to $5,000 each as long as your modified adjusted gross income as a married couple filing jointly is under $167,000.
You can learn more about the basics by reading Eric Tyson’s excellent primer, “Personal Finance for Dummies.”
Dear Liz: I am a single woman with a base salary of $101,000 plus bonuses, which so far have been significant. I divorced three years ago, and I am still digging out of debt. Last year I put all of my bonus toward debt but still have about $20,000 remaining. I will soon get another bonus of $38,000 before taxes and 401(k) contributions.
Is it wise to just pay off all the debt, or should I target the higher-interest-rate loans and put some in savings? I am thinking that I would have just enough to eliminate all my debt except my mortgage.
Answer: Debt comes in three basic flavors: toxic, good and neutral. Toxic debt includes credit card debt, payday loans and other high- or variable-rate borrowing. Good debt includes borrowing that can help you build wealth, such as a moderate amount of mortgage or student loan debt. Neutral debt includes everything that’s not actually toxic but that isn’t helping you build wealth, such as fixed-rate car or personal loans.
You should get rid of toxic debt as quickly as possible, so use your bonus to pay off any that you have. Then consider any neutral debt you owe. If you already have substantial emergency savings, you could pay off that neutral debt. If, however, you don’t have an emergency stash equal to at least three months’ worth of expenses, and your neutral debt has low rates, consider building up your savings instead.
Finally, make sure to review your spending and saving plans to make sure you’re living within your base salary. Bonuses are great but are variable by their nature, and you don’t want to count on them to pay your bills or bail you out of a jam.
Dear Liz: My wife and I are working to get out of debt, and I am interested in comparing the amounts we spend on mortgage, food, diapers and so on with what would be considered ideal or at least average for homeowners living in areas with a high cost of living. Do you have recommended percentages for various items? I am always looking for places where we can cut our expenses so we can pay off debt faster.
Answer: You can find averages in the U.S. Census Bureau’s annual Consumer Expenditure Survey, which you’ll find at www.census.gov. The categories are fairly broad — you won’t find a line item for diapers, for example — but the bureau provides averages for housing, food, transportation, clothing and insurance, among other categories. The bureau also slices the data various ways: by income, by metropolitan area, by child.
You may find the information more interesting than helpful, however, because every family’s situation is different. A couple with little debt and no children, for example, can comfortably afford a bigger mortgage payment than a family that has both kids and debt.
A better way to manage your spending is to use Harvard bankruptcy professor Elizabeth Warren’s 50/30/20 plan. Warren, who outlined the budget in her book “All Your Worth,” recommends limiting your “must have” expenses to 50% of your after-tax income. Must-haves include shelter, food, transportation, utilities, child care, insurance and minimum loan payments.
That leaves 30% for wants, including clothing, entertainment, gifts and vacations, and 20% for savings and debt payments.
Many families in high-cost areas find it extremely tough to keep must-haves to 50% of their after-tax pay. Some spend that much, or more, on their housing. But the 50/30/20 plan underscores how important it is to contain your basic overhead if you want to have money left over to pay down debt from the past, save for the future and enjoy your life in the present.