The Basics Category
Dear Liz: A lot of financial advice sites say you should have an emergency fund equal to three to six months of living expenses. What would be considered living expenses? Should you use three to six months of your net take-home pay or a smaller number? Is three to six months really enough?
Answer: Let’s tackle your last question first. The answer: No one knows.
It’s impossible to predict what financial setbacks you may face. You may not lose your job — or you may get laid off and be unemployed for many months. You may stay healthy — or you may get sick and your only hope might be experimental treatments your insurance doesn’t cover. Nothing may go wrong in your life, or many things could go wrong all at once, depleting even a fat emergency fund.
Having a prudent reserve of cash can help you survive the more likely (and less catastrophic) setbacks. Financial planners suggest that your first goal be three months’ worth of living expenses, typically defined as the bills that can’t be put off without serious consequences. That would include shelter, utilities, food, transportation, insurance, minimum loan payments and child care. Any expense that you easily could cut or postpone wouldn’t be included.
If you work in a risky industry or simply want a little more security, you can build your fund to equal six months of essential living expenses, or more. (The median duration of unemployment after the recent recession peaked at around five months, although many people were out of work for far longer.)
It can take many months, if not years, to build up even a three-month reserve. In the meantime, it can be prudent to have access to various sources of credit, including space on your credit cards or a home equity line of credit.
No matter how eager you are to have a fat emergency fund, you shouldn’t sacrifice retirement savings. For most people, saving for retirement needs to be the financial priority, with saving for other purposes fit in as you can.
Dear Liz: It has been almost one year since my domestic partner passed away, and our home of 43 years is fully paid for. I am ready to sell. The house is structurally in good shape but needs upgrades and a backyard redo. I have heard that painting both inside and out is a plus, but I’m concerned that any other improvements, such as flooring, would be my taste and not the buyer’s. Is it a wise idea to indicate that any major improvements be deducted from escrow funds?
Answer: You’re smart not to take on any major remodeling just before you sell, since few home improvements come anywhere close to paying for themselves. The fix-ups that typically do return more than they cost include painting, deep cleaning, trimming and freshening your landscaping, and de-cluttering. Consider storing half or more of your possessions. You’ll have to pack them up anyway to move, and getting them out of the way now will make your house look bigger.
Talk to your real estate agent about the advisability of replacing your floors. If yours are quite worn, the investment may pay for itself. Otherwise, a cleaning may be enough. You don’t have to offer to pay for the next owner’s improvements. Just price the home appropriately to reflect the fact that it needs updates.
Dear Liz: What’s the easiest way to save money? I have the hardest time. I want to save, but I feel that I don’t make enough to start saving.
Answer: The easiest way to save is to do it without thinking about it.
That usually means setting up automatic transfers either from your paycheck or from your checking account. If you have to think about putting aside money, you’ll probably think of other things to do with that cash. If it’s done automatically, you may be surprised at how fast the money piles up.
The second part of this equation is to leave your savings alone. If you’re constantly dipping into savings to cover regular expenses, you won’t get ahead.
People manage to save even on small incomes because they make it a priority. They “pay themselves first,” putting aside money for savings before any other bills are paid. Start with small, regular transfers and increase them as you can.
Dear Liz: How does a family without any income qualify for assistance? My son-in-law has had an Internet business for a few years. He did okay for a while, but not lately. Because he owns his own business, he can’t get unemployment. We’re paying for everything and can’t do it much longer. My daughter has a special needs child and is a stay-at-home mom. The kids have medical insurance, but the parents don’t. What steps are available to them to get the help they so desperately need?
Answer: If your son-in-law incorporated his business and paid into his state’s unemployment fund, he may qualify for benefits. If not, he can start his search for help at Benefits.gov, which is a federal Web site with links to a variety of assistance programs.
The fact that you’re helping the family financially is a blessing to them—but the fact that you’re “paying for everything” is a huge red flag. Families can fall upon tough times, but responsible ones have some savings they can tap and are diligent about finding ways to make money, even if it’s not as much as they were able to command in the past. If they can’t make ends meet, responsible families make changes—sometimes drastic changes—until they can.
What responsible families don’t do is continue relying on relatives until those relatives are bled dry. If your son-in-law isn’t actively looking for a job, he should be. If your daughter is the more employable one and can find work, then he could take over the child-care duties.
They may not take these steps if they think they can still count on you to pay the bills, so you need to be straight with them about your inability to continue supporting their family.
Dear Liz: I need help. I am getting ripped off by a company that advertises on television. The company bills your credit card for stuff you didn’t order. They need to be exposed and stopped. Can you help me? They don’t even have an email address to contact, and they seem to be ruthless. How can they be allowed to advertise on TV and fool the public? It is sick! I tried to cancel and they said it was already shipped.
Answer: You have far more faith in television advertisers than you should. Just about anyone can buy advertising time, including scam artists, as long as their check to the station or channel doesn’t bounce.
Call your credit card company and let it know you’ve been scammed. Then create a paper trail: Follow up with a written letter asking that the charges be removed, your account closed and a new account opened with different numbers, since the scammer may try charging you again.
In the future, you should regard all advertisers, whatever the medium, with skepticism. If you’re purchasing from a company for the first time, at a minimum you should research its return policy and make sure it has multiple ways to be contacted in case there’s a problem. An Internet search that combines the company’s name with the word “scam” also can be illuminating.
Dear Liz: My wife and I are considering buying a home for the first time. We’re planning to switch our accounts from our bank to a credit union. We’re in the midst of receiving a bad report from the bank, and that’s why we want to change. But is that a wise choice when we want to buy a home? Also, what options do we have for a mortgage when we don’t have any money for a down payment? Are we locked into an FHA loan, or are there other choices? We are middle-class people making an average of $40,000 a year with no kids and OK credit scores.
Answer: If you don’t have a down payment saved, you aren’t ready to be homeowners.
Homeownership is expensive, with lots of unexpected costs constantly popping up. Some are relatively minor, like having to replace a worn-out appliance, while others are major, such as having to replace a furnace or a roof.
That’s why homeownership isn’t a good idea for people who aren’t already in the habit of living below their means and saving a decent proportion of their incomes.
Take the next year or so to tweak your spending and save up a down payment. You’ll need at least a 3.5% down payment to qualify for an FHA loan. A bigger down payment will give you more loan options and won’t leave you upside down on your home from the first day. A 20% down payment is often best, since you can avoid private mortgage insurance.
A year also will give you time to polish those credit scores from “OK” to “good.” The higher your scores, the better the interest rate you’ll receive.
But the fact that you’re receiving a “bad report” from your bank is worrisome. You don’t specify what happened, but anything that could be reported to the credit bureaus, such as a missed credit card payment, could cause major damage to your scores. Simply switching to another institution won’t prevent that. And if you’ve piled up a bunch of bounced checks, your credit reports may not be damaged but you could find it difficult to open new accounts at other financial institutions.
Whatever happened, you should try to straighten it out with the bank before you decamp, even if you ultimately decide to switch accounts.
Dear Liz: We have a 7% fixed-rate mortgage with a $150,000 balance and a second, adjustable rate mortgage with a balance of $100,000. I’m self-employed and my wife doesn’t work. My income fluctuates a lot every month. We just sold a property and have $240,000 left after taxes. Should I pay off both mortgages or just the adjustable loan?
Answer: When deciding whether to pay off a mortgage, many people focus on how much interest they could save or what their “return” on their money would be. (If you’re in a 35% tax bracket for federal and state income taxes, for example, your return on paying off a 7% mortgage would be 4.6%.)
In reality, though, most people have better things to do with their cash than pay off relatively low-rate, tax-deductible debt.
Are you, for example, on track with your retirement savings? Do you have a substantial emergency fund? Most families would be wise to set aside a cash reserve to cover three to six months’ worth of expenses. Someone who is self-employed with a non-working wife might want to boost that emergency fund to 12 months’ worth of expenses.
Are you adequately insured? Since your wife is financially dependent on you, you probably should have a substantial life insurance policy. You may want to get one on her as well, if she cares for minor children and you’d have to hire a nanny if she died. You may also need disability coverage.
If you’ve covered all these bases and still want to pay off your mortgages, feel free. Otherwise, put the money to better use.
Dear Liz: I’m 55 and single with no dependents. I have about $250,000 invested. I rent an apartment in Los Angeles. I work in sales, which I can do anywhere. Would I be better off buying a house for about $150,000 now (somewhere in the middle of the country), thus reducing my living expenses (property tax and insurance will cost much less than rent) and leaving me with about $100,000 left for retirement, or just continuing to invest the entire $250,000 for retirement?
Answer: Moving to a less costly part of the country is a time-honored way to make your money stretch further in retirement. It also can help you save more for retirement if you dramatically lower your living expenses.
What you don’t want to do, though, is incur all the expenses of moving and buying a new home only to discover you hate where you’re living. Do substantial research and visit your targeted communities at different times of year before you commit.
Also, tying up 60% of your portfolio in a single, illiquid asset such as a home is risky. You may well be better off moving to a cheaper area and continuing to rent until you’ve built up a bigger nest egg.
Dear Liz: You recently had a letter from an adult whose financially irresponsible parents expected yet another bailout (“Parents expect another bailout from son“). As a therapist, I wanted to comment.
“No” is an emotionally laden word, and so few people are comfortable using it, especially when it comes to our own parents. If the 30-year-old were a client of mine, I would help him bear the pain and grief of loss. This is what any son who loves his parents and feels responsible for them must be feeling as he witnesses his parent’s financial troubles. Yet his hands are tied. The parents have a history of bad money behaviors, and the son can’t fix the problem that was probably present before his birth. “No” is the proper boundary.
If the son gives his parents a session with a financial planner, he must strengthen himself against further disappointment. If not, he will find himself in financial quicksand along with his parents.
Answer: Thanks for your response. While many would feel a moral obligation to help struggling parents, setting limits is essential. There’s also a legal component to this: See “Do you have to support your parents?“