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!

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.

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

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.

Weekly News Wrapup: Feburary 9, 2012

Major mortgage agreement between large banks and government authorities
http://www.nytimes.com/2012/02/09/business/states-negotiate-25-billion-deal-for-homeowners.html
http://www.usatoday.com/money/story/2012-02-09/mortgage-settlement-usa-today-cover/53033812/1

Unemployment applications drop dramatically
http://www.latimes.com/news/nationworld/nation/la-naw-unemployment-numbers-20120209,0,5615495.story
http://www.nytimes.com/2012/02/10/business/claims-for-jobless-benefits-fall-unexpectedly.html

Mortgage interest rates stay at record low
http://www.washingtonpost.com/business/average-rate-on-30-year-fixed-mortgage-stays-at-record-low-of-387-pct-15-year-ticks-up/2012/02/09/gIQACF321Q_story.html
http://news.businessweek.com/article.asp?documentKey=1376-LZ3GU06JTSE901-73MTU0VG6TQ74THH5SRDIHCIOO

Emergency Funds

Why have an emergency fund?
One of the core components of a healthy financial plan is an emergency fund. Many financial experts even recommend the emergency fund be your first financial goal. I agree with this sentiment. But why exactly should you have an emergency fund?

The main goal of an emergency fund is to cover unplanned expenses (aka emergencies) that arise so that you don't have to go into debt to cover those expenses. In particular, there are several different common major emergencies an emergency fund can cover:

• Car repairs and car replacement
• Medical visits and emergencies
• House repairs such as flooding and fires (if your home insurance doesn't cover or doesn't pay out immediately)
• Loss of job, or a loss of income do to disability, pregnancy, or some other emergency
• Expenses associated with family emergencies and tragedies
• Many, many other events that cost nontrivial amounts of money

So how much should you save up?
Ask 10 different financial experts and you will get 10 different recommendations, of which the most common are:

• Based on a number of months of expenses, typically 1, 3, 7, or 8 months
• Specific amounts, such as $5,000 or $10,000
• One year of expenses
• Whatever you feel "comfortable" setting aside or whatever is right for you

Some experts, such as Dave Ramsey, recommend a combination of the above in a step wise manner. He recommends first saving up $1000 in your emergency fund, paying off debt, then saving up 3 - 6 months of expenses. I agree with Dave with his methodology of first starting an emergency fund, paying off debt, then finishing up the emergency fund. But I disagree with the amounts.

Rather than first saving up $1000, I recommend to first stop living paycheck to paycheck by saving up one half to one month of expenses. Once you have it saved up, then you should be able to cover situations such as minor car repairs, buying a beater car if your car needs to be replaced, a doctor visit, a loss of job or disability for up to one month, and expenses associated with family emergencies. Keep half of your money in your checking account and the other half in either a traditional or money market savings account. This will help cover some emergencies where you don't have time to transfer the money from the savings account to the checking account and will prevent you from over-drafting in such an event. It will also prevent you from over-drafting if the timing of paying your bills doesn't work out exactly as planned and a large bill is paid the day before payday.

After you have paid off your debt, save 3 months of expenses. The three months of expenses would be able to cover the estimated average out of pocket maximum towards medical expenses (1) before health insurance pays out, loss of job or disability for three months, and cover some substantial house repairs. At this point I recommend to start saving 10% of your income towards retirement.

But your emergency fund still isn't complete yet. Why? Because 3 months of expenses doesn't cover the average duration of unemployment. From 1948 until 2008, the average duration of unemployment was between 7 and 20 weeks (2). If you save up 6 months of expenses, then you should be able to cover all of your expenses long enough to get a new job. It will also help cover many major house repairs and cover your expenses up until long term disability insurance kicks in, which is usually around 6 months (3). Once you have set aside 6 months of expenses, your emergency fund is complete.

References:
(1) http://www.goinsurancerates.com/health-insurance/out-of-pocket-expenses-series-maximum-limits/
(2) http://economix.blogs.nytimes.com/2011/06/03/average-length-of-unemployment-at-all-time-high/
(3) http://employeebenefits.about.com/od/ancillaryinsurance/a/LTDBasics.htm

Types of Savings Accounts

There are many different types of savings accounts available at banks and credit unions, and it may be difficult keeping track of the advantages and disadvantages of each type of account. Here is a quick rundown of the basics to each type of account:

Traditional Savings Account - A simple account available at just about any bank or credit union intended to hold money you set aside for any number of reasons. These accounts tends to have the fewest, if any, limitations on balances, very low minimum balances requirements, but also pay the lowest interest rates.

Money Market Account - Similar to the traditional savings account, except the interest rate is tied to the interest rates of money markets, which is a part of the financial markets for short term lending. These accounts have a slightly higher interest rate than traditional savings accounts, but tend to have higher minimum balances requirements (in the 1000s), and a low limit on maximum transfers per month (3-6 usually). There is sometimes a delay when transferring money out of the account. They are also offered at most banks and credit unions.

High Yield Savings Account - A savings account with a high interest rate that is usually a money market account, so it has all of the same limitations as a money market account. In addition, there is nearly always a delay when withdrawing money from this account when not using checks. A few banks and credit unions have these accounts, but they are now mostly available at online banks. Many people choose not to use a high yield savings account because the money is not immediately available.

Certificate of Deposit (CD) - A deposit you make at the bank where you agree to leave the deposit at the bank or credit union for specified amount of time, which is also known as a maturity date. Once the money has stayed at the bank to the maturity date you are paid interest on the money and allows to pull the money out. The longer you agree to leave the money in, the higher the interest rate paid to you. If you choose to pull the deposit out of the bank prior to the maturity date, then you forfeit the interest and pay an early withdrawal penalty. In the past CDs had interest rates that were noticeably higher than other types of savings accounts, but nowadays pay about the same interest rate. Unless you know that you will not need the money for a long time, CD's usually are not work the risk of early withdrawal penalties.

Health Savings Account (HSA) - A special savings account intended to hold money set aside for medical expenses available to people who have a high deductible health insurance plan. HSAs are tax advantaged in the sense that deposits to the account can be made pre-tax, and withdrawals are not taxed as long as they are used for approved medical expenses. HSAs tend to pay about the same interest rate of a money market account, and some banks allow the money can be invested. There is a federally mandated limit on the amount that can be contributed to HSAs annually. If money is pulled out for non medical expenses, than there is a penalty of 10% plus the owner will be charged tax on what is withdrawn.

Purpose of Savings Accounts 

Many people set aside money for different purposes, ranging for saving up for anything from upcoming expenses (short term savings), to expenses that are several years away (long term savings). However, the most recommended is an emergency fund. An emergency fund is just as the name implies - money set aside for times when there is a financial emergency. For example, common emergencies include a lost job, paying for car repairs or a car replacement when a car breaks down, severe damage to a house, or paying for a medical emergency. Some people also set up sinking funds, which is money set aside over time to pay for expenses that will happen but the time of the expense is unknown.

I have recommendations for how to split up your savings accounts, and why you should split up savings accounts, here.

Advantages of Multiple Savings Accounts

Have you ever asked your self, "Where did the money I saved for... go?", or "Hmm, I can't tell how much money I set aside for ...?" Chances are you need multiple savings accounts.

Multiple savings accounts help you keep your money organized. Each account has its own balance and transaction history. This allows you to quickly, and clearly, see which money is set aside for which expense without have to dig through one monolithic transaction history of one account. They also provide an explicit barrier between your accounts. You are much less likely to accidentally spend money for one expense that you have set aside for another simply because the check or debit card you use simply wont affect the account that hold the other expense.

Multiple accounts also provide a layer of protection from thieves. If someone manages to get a hold of your debit card or checkbook for your checking account or one of your savings accounts, your money in the other savings accounts would be protected. The thief would not have immediate access to that money in the other accounts.

If your bank imposes transaction limits on your savings accounts, they may impose the limit on individual accounts rather than one transaction limit for all savings accounts. If so, setting up multiple accounts effectively multiplies the allows number of transactions you can make before you hit your transaction limit. In addition, some banks do not impose limits for transfers made between savings accounts online, making it easier for you to reassign money as you like. Check with your bank to find out their savings account transaction limit policies.

If you have been avoiding setting up multiple savings accounts because of the hassle factor, then you would be pleased to hear that creating new savings accounts are easier now than ever before to setup. Many banks now provide options to quickly setup additional savings accounts online without having to go through the effort of filling out paper work or driving to a branch. You could even choose an online bank so you never have to leave the house.

So how should the money be broken up?

At a minimum, put your emergency fund in a separate savings account. This guarantees that every time you take money out of the account it is intentional. This account would be a good choice as a high yield savings account since the balance should be relatively high and steady.

After you have setup your emergency fund account, the next step would be to split your savings into a short term savings account and a long term savings account. The short term account could hold expenses that usually take less than a year to save up and are relatively small expenses. For example, this account could hold things such as quarterly insurance premiums, money for Christmas gifts, or any other lump sum expense you plan to make throughout the year. The long term savings could hold things that take are major expenses, such as vacations, car replacement, furniture replacement, or down payments for house. Many people decide to go even further and breakup their long term savings into more accounts for specific goals to keep track of the balance for each goal.

Regardless of how you much you separate out your savings, the point is that you keep track of your savings. If it's easier for you to keep track of just one savings account, then have just one savings account. If keeping track of your savings in one or a few account, then split it out into more. Just know where your money has gone, where it is, and where it will go.

Lesson Learned: Financing purchases and no money down

What have you financed in the past?

The spring of my senior year I had finally decided to take the plunge and ask my girlfriend to marry me. I thought in order to propose I had to buy an engagement ring, even though I had no money to buy it. Oh well, I could just do one of those no money down deals that are everywhere now. So off I went looking for an engagement ring. I spent a grand total of 1 afternoon looking and I found one I liked, so I bought it on the spot. All I had to do was get a store credit card and the purchase would be put on it.

When I made my first payment I decided to look at the terms of the card and I was shocked. If I missed one payment, did not meet the minimum payment every month, or did not pay off the credit in one year, I would be back charged interest for every month since I made the purchase at an extremely high rate. I would then be charged interest every month until I completely paid off the entire balance. Luckily, I managed to get a job around that time and was able to payoff the loan in 6 months. Whew i thought, I dodged a bullet there.

After we were married for about a year we decided to buy a house. As many of you know, anytime you buy a house you never just buy a house. There is always an assortment of things you buy when you move in, and we were no exception. We must buy new furniture even though we already had hand me down furniture. So we went to the furniture store and bought a living room set consisting of a couch, a chair, and three stools. And I found myself in the same situation as I was in with the engagement ring - on pins and needles hoping my I would have enough money to make the payment every month in time because our budget was already tight. We were able to eventually pay off the furniture before the deadline and I was able to relax again.

Two and a half years after we wed we were expecting our second daughter. We knew we had to move the baby into the baby room and move our older daughter into her own room, which means we needed to buy her a bedroom set. So we decided that every month we would save up a $150 a month until the baby was born and we would be able to save up enough to cover the bedroom set. We did as we planned, and a couple of months before she was born we were able to finish saving up enough money ahead of time.

We went to the furniture stores and found something we liked for a decent price. If we had planned to purchase the set on credit we probably would have purchased the set right then and there, but with the cash in hand we decided to wait for a deal. And so we waited..and waited..and waited. Then the furniture store had the set on discount for 10%, so we went up to the store to buy. We asked since we have cash, could they cut us any other additional deals..and they gave us roughly a 10% additional discount. So just by having the cash on hand and waiting we managed to save nearly twenty percent, and without the risk of the financing.


We have decided to never finance purchases again, particularly for the following reasons:

1. No money down deals are extremely risky because the lender can easily back charge you interest at high interest rates
2. Major purchase items have financing costs built in - stores are willing to discount when paying with cash
3. Financing can added extra stress due to fear of late fees, penalties, and limiting the amount of money available for other expenses every month
4. Spending with cash gives you freedom to browse and say no without feeling the need to make the purchase right then and there

Next Lesson Learned: Buying a house

Lesson Learned: Paying for college with student loans

How long did it take you to pay off your student loans?

I remember the fall semester of my senior year in high school the teachers went on and on and on about applying for scholarships. I remember thinking that scholarships were only for the students with the most extracurricular activities, best grades, and most skill on sports, and that there was no point in applying because I would never get them. Eventually I applied to maybe 3 scholarships and I got one. I thought I was lucky and was ahead of the curve.

Towards the end of the year the school had a senior awards ceremony. During one of the awards presentations the award presenter mentioned that the award recipient had sent out *hundreds* of scholarship applications - and was awarded over 50 scholarships and grants. Needless to say, her school was paid for. So much for my one scholarship.

I received some help with paying for college from my family, but I needed to find a way to cover the rest of my college expenses. At that point I had two options: work during school or get student loans. I chose student loans because I thought that if I worked, I would end up flunking out because I didn't have enough time to study. I also figured that it was normal to have student loans and, besides, most people can pay them off quickly after college.

When I started the loan process I quickly found out that I needed a cosigner. I eventually asked my family to cosign for me, and they obliged. But after I received the loans I always felt uncomfortable visiting them. In the back of my mind I kept thinking of different scenarios that would make me unable to pay my student loans. What if I ended up dropping out of college? What if I couldn't find a job? What if the job didn't pay enough? What would I say to them, sorry? Holidays never felt the same again.

Fast forward to graduation and I had built up slightly over 40k in loan debt. 11 months later I married my wife, and she had some where around 8K loan debt. By the time we were married all student loans had entered repayment. We figured if we paid a substantial amount each month we could pay them off in a couple of years. But after a few months, life happened and we found out we were expecting our first daughter 9 months (to the day) after our wedding. Student loans fell down the priority list and we realized that we were not going to quickly them off,

We will make our last student loan payment this May, over 4 years after we started repaying. Then we can finally put college behind us. Altogether, we will have paid over 60k in principle and interest. We would have loved to used that money for other things, especially using it as a substantial down payment towards our house and setup an emergency fund.

If I could relive my senior year in high school and college, there are things I would have done differently:

1. Paid more attention to my grades to improve my chances for scholarships and grants.
2. Apply to as many scholarships and grants as possible. Nothing beats free money.
3. Work during college to pay off the rest of my expenses.

There are also a few other things I have learned in regard to student loans:

1. The relationship between a signer and a cosigner is strained, whether they consiously or subconsciously realize it.
2. Don't rely on things going perfectly to pay off student loans. Life happens and student loans are an unnecessary burden.
3. Student loans limits your opportunities and choices after college

Next up: Financing purchases and no money down

Lesson Learned: My First Credit Card

What were your experiences with your first credit card?

The summer prior to my first year at college I was mostly hanging out until dorms opened up. One day I got a call on the phone from a banker asking if I would like a credit card. My first reaction thought was, "Hmm, why would I need a credit card?". He must have sensed this because he started talking about all of the things you could buy with one, the financial freedom I would have, and how it was such a great offer because it would help me establish a credit history. So I said yes, without ever discussing credit limits, minimum payments, interest rates, or late payment fees.

I promptly got the card in the mail a few days later. When I held it in my hand I had a huge rush of adrenalin - wow, I had a credit card. I had power now. Adults have credit cards - that means I'm an adult now! I started using it immediately.

After a few months the adrenalin of the credit card had worn off and I started looking at the details of the card. The interest rate was 12% with a cash advance and wire interest rate of 30%. The interest rate would also jump to 30% if I made any payments late along with a $20 minimum late fee. I suddenly realized how easy it was to mess up using the credit card and promptly stopped using it..for a time.

About a year and a half after I got the card I started using it again. But this time I told myself that as long as I made it a point to make the payments in full on time, I would be just fine. But sure enough, I missed a payment by a day, and it cost me $20. Then I missed another, and another, and another..and I had just about had it with the card and I was about to cut it up. Then I saw an ad one day for a rewards program I could sign up for with the card. So I signed up for it thinking that I would be able to earn a substantial amount of money in rewards that I could use when I graduated college.

Fast forward about 3 years after I graduated and I had built up about $300 in rewards. In the meantime, I had paid roughly $200 in membership fees to stay in the program. Wow, all of that time and effort to stay on top of the credit card for a lousy $100??? Not to mention that I had subconsciously decided to buy some things that I would have otherwise not purchased if I didn't have the rewards program, which I'm sure cost me more than the $100 I had earned. I decided it wasn't worth it and canceled the card.

But canceling the card was hard. It took me 3 months to follow through with cancelling it - it was my first card after all. Now, I only use cash or my debit card. There are no membership fees, late payments, or accrued interest. There are no emotional highs, no emotional lows, and no concerns whether the payment went through in time. Just money.

So when all was said and done, I had learned:

• I had made a financial decision without fully understanding the consequences of my decision
• Getting my first credit card was an emotional roller coaster
• Having a credit card is a financial burden, not financial freedom - it was just as easy to slip up using a credit card than it was to use it "responsibly"
• The credit card rewards program was in place to make the bank money, not me
• I spent more money using the credit card than using cash because spending cash hurts

Next up: Paying for college with student loans