Using cards as an emergency fund can hurt your scores

Dear Liz: Help! In the last year, my credit scores have dropped 30 points. I don’t know why except that my credit reports noted that I used 10 credit cards recently. (I’ve had many dire emergencies lately, but I paid off all my balances as usual.) I’m terrified of more drops. What can I do?

Answer: Build up your emergency fund.

Because you charged your emergencies, you used up more of your available credit. The more of your credit you use, the more negatively your scores tend to react. It doesn’t matter that you paid your balances off each month. What counts is the balances that your credit card issuers report to the credit bureaus, which are typically the balances on your latest statements.

Now, the good news is that your scores probably will recover as soon as you start charging less. But you should take this as a sign that credit cards are a poor substitute for savings. An emergency fund could help you survive life’s inevitable setbacks without having to run to your cards.

Money troubles? Stop bailing out your kids

Dear Liz: My husband and I are having a rough time making it from paycheck to paycheck. We make pretty good money. We have four children and end up helping them every month. We cannot seem to make it without going in the hole in our checking account. Could you please help me with what we should do?

Answer: As writer Erica Jong once said, advice is what we ask for when we already know the answer but wish we didn’t.

You know what you need to do: Cut off your children (assuming they aren’t minors, of course). If you can’t make it from one paycheck to the next, you’re in no position to help anyone else. Your children may not know the financial straits you’re in, or they may not care; either way, it’s up to you to close the Bank of Mom and Dad.

Once that financial spigot is shut off, you’ll need to look for the other leaks in your financial system. Track where your money is going using personal finance software such as Quicken, online tools such as Quicken Online, Yodlee or Mint, or a notebook and a pen.

If you’re still spending more than you make, you’ll need to find ways to cut back so that you not only don’t go in the hole but are putting aside money each month. You need to save for retirement and for an emergency fund, among other goals.

To do all this, you’ll need to use a word that apparently hasn’t been given enough of a workout around your home: “no.” “No, we can’t help you.” “No, we’re not going to buy that.” “No, I’m not going let my finances be in chaos because I can’t say ‘no.’ “

If you can save for college, you should

Dear Liz: I would like to know how best to use a $100,000 inheritance. I am a stay-at-home mom, age 46. My husband, 42, earns $100,000 a year.

We owe $132,000 on our house and have no other debt. We pay off our one credit card in full monthly. He puts the maximum into his 401(k). We have two sons, ages 5 and 8.

Should we use the money to pay down our mortgage? I’m not interested in saving for college. We will be retiring about the time the kids are ready for college and we plan to have them take out student loans.

Answer: If you can save for college, you probably should.

College costs show few signs of moderating, so your older child might face a bill of $140,000 for an in-state public college or $200,000 or more for a private or selective public college. The cost for your younger child will be even higher. If they borrow the entire cost, they’re likely to remain financially disadvantaged for years. Students who overdose on loans often can’t save enough for retirement and delay starting families and buying homes because of their debt. Anything you save for them could reduce that terrible burden.

You also might want to rethink the idea of retiring when they start college. Even if your husband has been maxing out his retirement fund, it’s unlikely he’ll have saved enough by age 52 to last the rest of your lives, particularly if you have to start paying for health insurance on your own. (Medicare isn’t typically available until you’re 65.)

You didn’t mention savings. Most people should have an emergency fund equal to three months’ expenses, but families with just one earner typically should shoot for six or even nine months’ worth.

In any event, you almost certainly have better things to do with your money than pay down low-rate, potentially tax-deductible debt such as a mortgage.

A better approach might be to divide your inheritance into thirds, investing a third into an emergency fund, a third into your boys’ educations and a third into retirement funds.

A visit to a fee-only financial planner could help you sort through your options and clarify your goals.

Facing a layoff? Rule #1: Conserve cash

Dear Liz: I am looking at a layoff in the near future, possibly in 2 to 4 months. I have paid off all my credit card bills and use them sparingly now. I have several loans, including $25,000 left on my mortgage plus car, truck and personal loans that total about $60,000. I have enough savings to pay them off. If I get laid off, is it better to pay off the loans or to use the saving to continue to pay them monthly?

Answer: When you’re facing a layoff, you should be conserving cash. That means paying the minimums on any debt and looking for other ways to trim expenses as much as possible. Selling one of your vehicles might also be in order.

Try to avoid tapping any retirement savings, since you’re likely to incur penalties and taxes if you do so, plus you’ll lose all future tax-deferred return that money could have earned. Dip into other savings sparingly, as you may be without a job for awhile.

You need to batten down the hatches because you may be without a job for months. The median length of unemployment in July was nearly 15 weeks, up from 10 weeks in July 2008. A whopping five million people have been without jobs for 27 weeks or more. Given the environment, you should consider any job that will provide income and help you conserve your cash.

For a budget that works, get control of your debt

Dear Liz: I am a single, 38-year-old mother of a college student and make about $80,000 a year, which isn’t too bad considering my upbringing. My parents were alcoholics, and thus I never had a financial role model. Now that I am making decent money, I need to know how to spend it appropriately. What I mean is that even though I bring home $4,000 a month, you would think that I make minimum wage if you saw my house and the way I live.

I think the problem is that I spend a lot of money on wasteful things such as eating out. I try to track my spending but don’t do it consistently. I would like to stop wasting money and buy a bigger, better home than my current town house. I spend $845 on my mortgage, including taxes and insurance, have two car payments totaling $700 plus $200 a month for insurance, utilities of $200, a home equity line of credit payment of $200 and a student loan payment of $200. I also have $4,000 in credit card debt. I contribute 6% to my company 401(k), which has a 3% match, but I don’t have an emergency fund. I know I should be paying myself first, but I don’t know how much. I’m just at a loss. Can you help?

Answer: First, give yourself credit for what you’re doing right. You bought an affordable home, you’re keeping up with the payments, and you’re saving for retirement.

Your big problem is your debt. Your car costs alone are high, given your income and other expenses. That $200 payment on an interest-only home equity line of credit indicates you’re carrying substantial debt there as well. And the proper amount of credit card debt is zero. All these indicate you’re living above your means, despite how you might feel.

If you want a budget that works, get your “must have” expenses down to 50% of your take-home pay. That includes your housing, transportation (including gas), utilities, food, insurance and minimum loan payments. Then you can devote 30% to “wants,” such as clothing, vacations, entertainment and dining out. The remaining 20% of your pay goes to savings and debt repayment, starting with that credit card debt. (Harvard bankruptcy expert Elizabeth Warren explains this budgeting system in her excellent book “All Your Worth.”)

Getting car debt under control can be difficult. Ideally, you’d sell the two cars and buy less expensive replacements with cash or by using four-year loans with lower payments. Often, though, people who owe this much on their cars are “upside down,” owing more than their cars are worth. When that’s the case, it’s best to “drive out of the loan” by continuing to make the payments until you’ve paid off the debt, then keeping the cars for several more years until you’ve saved up cash for their replacements. If possible, your college student should get a job and help contribute to the cost of her car.

Consistently tracking your expenses will help you identify areas of overspending and help you stay within your budget. If your current method isn’t working, consider using one of the online sites such as Mint.com or Quicken Online, which automatically gather and tally your bank and credit card transactions.