Thursday, February 23, 2012

Long time, no post!

The last week or so I have been taking it easy. I will be back next week, posting each day form Monday through Friday for a theme week: Debt Repayment. I will be covering things such as the basics including why you should stop borrowing and pay off debt, when to do it, and describing different methodologies for paying debt off.

See you next week!

Thursday, February 16, 2012

Building your emergency fund

Have you ever had trouble setting aside money for a rainy day? You're not alone. 25% of people have no emergency fund and another 22% have less than 3 months of expenses saved up. That means that if a major emergency happens nearly half of Americans will end up going into debt. But how do you get started?

First, understand why
The first step in building an emergency fund is to understand why you need an emergency fund. Once you know why, understand that people develop their spending habits over months and years, so deciding to stop wasting money is akin to deciding to end an addiction. You have to have a plan.

Set Goals
Decide when and how much you want to save up so that you know how much you need to save each month. For example, say you decide to save up 1 month of expenses in five months. If you normally spend $2500 a month, then you will need to save up $500 a month to hit your goal. Be realistic with how quickly you can save up. It is better to choose a slow savings amount and hit your monthly savings goal each month than to miss your goal and get demotivated. If you know you can save up only so much a month, set your timeline based on that savings rate.

Limit recreational activities
Choose 1 expense you know you can eliminate, such as a meal out to eat, going to the movies, or some other recreational activity. The day you normally spend that money, instead put the money in your emergency fund account and spend the time doing something cheap or even free. Doing this over the course of several months can add up. For example, say you cut back eating out twice a month for a year where the meals cost $30 apiece. You will have saved up $720, just by slightly altering your spending habits.

Save windfalls
Many people file their taxes and get a substantial tax refund they can use toward building their emergency fund. If you receive a tax refund or some other relatively small windfall, use some of it for fun and put most of in your emergency fund. Take for example the average tax refund: $2,913. You could set aside $213 for fun and put the other $2,700 in your emergency fund. For many people that is a whole month of expenses and could allow them to stop living paycheck to paycheck and start tackling debt.

Pay off debt
Once you have 1 month of an emergency fund you can start working on paying off debt. The quicker you pay off your debt, the quicker you will be able to free up money that you can use to save towards your 3 months of expenses and eventually your six months of expenses. And whatever you do, stop borrowing more money.

Make it automatic
Most employers that provide direct deposit will allow you to direct deposit money into a savings account. The benefit of this approach is that you never see the money in your checking account, and as a result never feel the urge to spend it. If you are don't like the idea of not immediately having the money available, you could setup an automatic transfer shortly after payday. Making your savings automatic forces you to save and helps for the times when you would otherwise forget to save money.

Get a second source of income
Nothing helps build up emergency savings like having more money available to save, and a second source of income would provide just that. You could do anything from a getting a part time job, to selling your stuff online to tutoring students. The options are just about endless.

Sell your car
If you have a car with significant value sell your car and buy a cheap one. Doing so could help you add several months worth of savings to your emergency fund. If you have a car payment, get rid of it and buy a cheap one. Then use the freed up money each month to put towards your emergency fund.

Cut the cable
We did this and we have saved ourselves over $700. You may still be able to see many of your favorite TV shows and sports using just an antenna and free online services.

Use it only for emergencies
An emergency fund is for unforeseen emergencies, not for holiday decorations, vacations, prom dresses, or birthday gifts. Set up a short term savings account and put money aside each month for the things you know will come up. A little bit of planning will help you avoid dipping into and draining your emergency fund.

This is only a small sampling of ways to help buildup your emergency savings. What methods have worked for you? What didn't? Feel free to discuss.

Tuesday, February 14, 2012

Happy Valentines Day!

I hope you are enjoying your valentines day/week with your significant other. Remember not to break the bank!

The next post will come on Thursday - Tips for saving up your emergency fund

Monday, February 13, 2012

Lesson Learned: Buying Our First House

What would you have done differently the first time you bought a house?

The first year of my marriage, my wife and I had only casually talked about buying a house. We talked about how nice it would be having our own place, how comfortable we would be moving into a place larger than a 2 bedroom apartment, and how at ease we would feel once we could settle down. We had no intentions to buy a house anytime soon though.

Then one day we heard on the news that the federal first time home-buyer tax credit would be extended several months into 2010. We felt it was just too good to pass up, and we decided to go ahead and take the plunge of homeowner ship. We spent a few weeks looking at houses, but we didn't care for any of them, in particular the floor plans. We eventually decided that we wanted to go with a completely custom house rather than settle for something we didn't really like.

So we went through the design and build process. We had to close by the end of June to guarantee we would get the tax credit, so we were constantly giving feedback and decisions to the builder as quickly as possible so that we would not be the delay in the building process. We managed to scrape up the bare minimum closing payment for an FHA loan and the house was completed in time to sign the contract on June 30th, on the deadline.

A few months later after we started making mortgage payments, I started to realize that we were taking some significant risk with buying the house. The mortgage payment at the time was about 30% of our income, and when considering our student loan payments and furniture payments, about 50% of our income was going towards debt. We managed to pay off our furniture loan prior to when our second daughter was born. Up until then my wife had been working near full time, but then she had to stay home with the newborn at least for a few months, so we lost her income. We were now paying over 55% of our income towards debt. Luckily, we were able to make the payments, but at the same time we were not able to set aside any income for savings or investments. We couldn't afford to look toward the future, like some other people were trying to do around us.

One couple in particular near us were trying to sell their house. We knew that they had taken the first time home buyer tax credit, but because they were moving shortly after they bought the house they would have to repay it. Unfortunately the were trying to move at the same time when houses were still being built around the corner. They eventually had to settle for selling the house at a 19k discount, and they were out nearly 27K. If something had happened that forced us to move, we wouldn't be able to afford it and would of had to put the house up for foreclosure. I imagine that's what happened to one house by us that eventually went into foreclosure after the owners tried to sell the house for over a year with no luck.

Looking back if I'm not sure what we would have done differently, but we did learn some lessons to consider the next time we buy a house:

  • Pay down debt prior to buying a house. Paying a mortgage and other debt at the same time puts unnecessary strain on your budget.
  • Save up a substantial down payment to avoid mortgage insurance. It will also help you avoid going "underwater" on your mortgage loan.
  • Get a conventional loan of possible. FHA loans are loaded with extra closing costs that are better served going towards equity in the house.
  • There are thousands of dollars of expenses when moving into a your first home. Expect to buy furniture, appliances, and other miscellaneous house items.
  • Building a new or custom home comes at a premium. Save some money by buying a house with a previous owner, or better yet, do some homework and buy a foreclosure in a developing neighborhood.