Dear Liz: My wife and I are planning to have a child in the next couple of years, and I realize that I have no idea how to go about preparing for that financially. How much cash should new parents try to have available? What else should we be considering?
Answer: Congratulations in advance on your entry into the great adventure of parenthood. The most important thing to know is that you can’t predict what’s ahead, financially or otherwise.
The U.S. Agriculture Department estimates that it will cost middle-income parents nearly $300,000 to raise a child to age 18. But your costs could be a lot less if you’re particularly frugal, or a lot more, particularly if you have a high income, plan to pay for private school or have a child with special needs.
You can get some idea of what to expect by using the Agriculture Department’s new calculator at www.cnpp.usda.gov/calculatorintro.htm.
Your annual food, clothing and healthcare bills typically rise $3,000 or more with each child. You also may opt for a bigger home or car, which can add to the bill. Child care and education are other considerable expenses.
Then there are the set-up costs. The authors of “Baby Bargains,” one of my favorite books about preparing for a child, say you easily can spend more than $6,000 just on equipment such as strollers, car seats, maternity clothes and nursery care. If you’re smart, however, you’ll try to spend a lot less, buying or borrowing used furniture and selecting well-reviewed, midrange brands of strollers and car seats rather than status brands.
You’d be smart to start trimming other expenses now and saving the difference, so that you have a fund to pay these start-up costs and so that the added expenses of a child don’t push you into debt.
If one of you is planning to stay home with the baby for an extended time, consider starting to live on one income now and banking the other.
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.
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.’ “
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.
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.
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.
Dear Liz: Like many Americans, I often must scramble to make ends meet between paychecks. I vigilantly monitor my account online, and when my balance is getting low, I curb my expenses as best I can.
Recently, I have had an overdraft experience that leaves me wondering about ethics and legalities. It was three days from payday and I had about $45 in my account.
I made four purchases under $10. Then a $54 automatic payment came through that I could not reschedule. One would think I would then be charged one overdraft fee, as all of the previous purchases made were within my available funds at the time.
I logged in today to find that the bank cleared the largest transaction first, which threw all other small transactions into overdraft. I was charged five overdraft fees because of this rearrangement of clearance order. I talked to a customer service manager who said that nothing could be done.
Essentially, it appears that the bank is manipulating transactions to capitalize on overdraft fees. This strikes me as unethical, and I wonder if I have any rights in this situation? Aside from getting a better job and making more money, what can I do to protect myself?
Answer: Of course the bank is manipulating your transactions to increase its fees. Most banks do. Lawmakers and regulators have questioned the practice, but so far it’s not illegal.
What you can do to protect yourself is to stop living paycheck to paycheck. That may sound like a flip answer when you’re on the financial edge, but you’ll never get ahead as long as a $54 overdraft can throw your finances into chaos.
Having just a $500 cushion in the bank can reduce not just bounced-check fees but also worry, sleeplessness and lost productivity at work, according to a savings review by Stephen Brobeck, executive director of the Consumer Federation of America.
How do you get a cushion? Try a “no spending” month. Limit your purchases to true essentials. Eat out of your cupboards instead of at restaurants. Entertain yourself at home or at the library. Most people can raise at least a couple hundred dollars this way, which you could supplement by having a yard sale and selling unneeded items online.
If you want more ideas, there are a wealth of frugal-living websites; start with one of the oldest, the Dollar Stretcher, at www.stretcher.com.
You also need to limit the bank’s ability to swamp you with “gotcha” fees.
First, sign up for true overdraft protection. Banks often automatically enroll you in an inferior substitute, called “bounce protection” or “courtesy overdraft.” These programs allow the banks to approve over-limit transactions and charge you $30 or more for each one.
True overdraft, by contrast, links your checking account to another of your own accounts: typically a savings account, line of credit or credit card. If your transaction exceeds your balance, the money is drawn from one of these accounts. You’ll pay an annual fee of around $50 and possibly a $10 per transaction fee, but the costs for making a mistake will be substantially lower than under bounce protection.
If the bank won’t approve you for true overdraft, ask it to stop approving over-limit transactions. If it won’t, take your business elsewhere.
Dear Liz: My husband and I have not had any credit cards for almost 10 years. We just paid off our vehicle with his retirement account. We now owe only for our home. We have no other debt except utilities. I draw a disability check each month, and I keep thinking we should be able to save but have been unable to. We are not extravagant by any means, rarely going out to dinner or movies. What are we doing wrong?
Answer: Well, for one thing, you drained a retirement account to pay off debt. That’s extremely shortsighted, because you incurred unnecessary taxes and perhaps penalties to tap money that should have been left alone to grow. (And yes, it will grow again. Eventually.)
What’s probably happening is that you’re waiting to save until all your other expenses have been paid. That rarely works, because expenses have a mysterious way of rising to meet your income.
You need to turn your priorities around and save first — something out of every paycheck or other money that comes your way.
The best way to do that is to put your savings on automatic, so the money is swept out of your checking account into a high-yield savings account. If you have to make a decision each paycheck to save, you’ll typically find other things to do with that money.
If you try that and find yourself still falling short, it could be because your fixed expenses are out of whack. Often, when people aren’t extravagant but still have trouble saving, the reason is a home or a car that’s eating up too much of their incomes. If you’re spending much more than 25% of your gross income on housing or 10% on your car, you may find yourself having trouble making ends meet.
Dear Liz: My husband and I make good money. We have a low-rate mortgage, a good amount in savings, and our retirement fund is well on its way, despite recent losses. We still have 25 years until retirement. What’s the best thing to do with our extra money? We have been putting it into projects to spruce up the house but otherwise just throw it in savings.
Answer: How about investing some of it in a session with a fee-only financial planner? That’s the best way to know if you really are on track for retirement, if you have enough emergency savings and if you’re adequately insured.
You can get referrals to fee-only planners who charge by the hour at Garrett Planning Network (www.garrettplanningnetwork.com) and the National Assn. of Personal Financial Advisors ( www.napfa.org).
If your finances are indeed as rosy as they seem, then you may want to consider enjoying your money a little more. Research shows us experiences make us happier than possessions, so consider a special vacation or travel to see family and friends.
You also might consider boosting your charitable donations to share your good fortune in these increasingly hard times.
Dear Liz: We have about $800 extra each month after paying bills, but we aren’t sure we’re doing the right thing with it. Should we pay down our adjustable-rate, maxed-out home equity line of credit? Or do we put it toward our savings, which has only $5,000 right now?
Answer: Before doing either, make sure you’re saving adequately for retirement. You may be tempted to cut back in this uncertain market, but the costs of retirement are so great that you need to start saving early and not stop if you want to have a sufficient nest egg. Your human resources department at work probably has tools to help you.
If you’re convinced you’re on track there and you don’t have any credit card debt, the next step normally would be paying down that home equity line. In today’s environment, however, you might find your lender lowering your limit as soon as you start to reduce your balance. Rather than freeing up credit that you could use again in an emergency, paying down your HELOC may actually reduce your overall financial flexibility.
This might not be an issue if you have tons of equity. If your current mortgage balance and your line of credit total less than 60% of your home’s current value, you may not need to worry about your lender reducing your credit limit.
If your loans total more than 60%, however, or if housing values are falling fast in your area, consider instead building up your savings.