As we turn the page on a new year a lot of people want to set a goal or a resolution for the new year. Most of the time these usually get forgotten within a few weeks of the new year and usually consist of being healthier or being a better person, or what have you. But this year because no one at all, NO ONE, asked here is your FREE financial advice for 2017. A great resolution for 2017 is to get your finances in line or set a financial goal.
But first I have to mention a few little legal clauses that I must disclose. I am not a certified financial planner or advisor in any way, and if you choose to hire one the first question you should ask them is, “ARE YOU A FIDUCIARY?” If they say no, tell them thank you, get up and walk out of the office. This is just my opinion. But here is some free advice about what I would do if I were you or just some basic fundamental good financial rules to keep in mind as you journey though life. Most of this is just information that you can easily find on the internet, but I find is fascinating and interesting. How my 30 something are legitimately worried about retirement (you cannot see but my hand is fully raised). I also threw in some advice or how I would approach a few scenarios as well.
No matter what you do in life money is more than likely involved. Some people are great with money while others not matter how much you give them will always struggle to make ends meet. So all things being equal why not have some sense (haha) when dealing with money and at the very least make some good decisions that will pay dividends (this is too easy), both figuratively and literally, in the future.
I think the three most important things are to first, make a budget, second automate your savings (if you are able), and lastly get a credit report. These are very important and no matter who you talk to at some point they will tell you one of these two things. Dave Ramsey is especially fond of making a budget as well as paying off debt, but we will get into that in a second. But making a budget is the most important financial device you can create to take a step to financial security.
When you create your budget you can actually see where your money is going, and sometimes this is an eye-opener. Most people do not carry cash, they just use a credit or debit card and studies show that people tend to spend more when they are not using cold hard cash. So actually tracking what you spend will open your eyes to a few pennies or dollars that you could save by bringing your lunch or not stopping to get a cup of coffee. This is also important for you to set up what it is you would like to accomplish for the next year and determine if it is attainable. It is important to set up a financial goal, and once you have that goal and your budget you can figure out a way to achieve that goal. It is important to remember that life will happen eventually along the way and attempt to derail your plan. So you will also need to have some sort of cash savings. Dave Ramsey says that 6 months’ worth of expenditures is necessary, I don’t think you need that much cash. Honestly I think about $1,000 is plenty to start with, BUT if you work in a volatile industry or rely on commission you may want to increase that depending on your expenses.
The reason I say $1,000 is because in today’s age you can use a credit card to pay for almost everything. So I do not think you need to hoard large amounts of cash, and again this fund is for an emergency. Something like a car repair or having to call a plumber or if the basement floods. If you know that you need a new roof for you house then you will obviously need more cash for that. But again if you think you could get fired or something crazy is going on at work you may want to save more cash, but if you have a steady income, work a stable job at a stable company I think $1K is plenty. If you have the ability to save more then by all means go ahead, but I do not think you need to have $5K or more in cash savings. I would say that $2,500 is the most you may want depending on your situation. Any more than that and you should be investing that money. So once you have that saved up then you can really work on achieving your goal.
I would bet that most people want to pay off debt as their goal, and this is where the budget comes into play. You want to see where perhaps some frivolous dollars are going or perhaps some extra income that you could use to achieve your goal is being spent elsewhere. That income will go a long way in paying off debt. I will personally admit that it was hard to do with out in the beginning, but after a few weeks you don’t even notice it anymore, or miss the dollars you were just throwing away or spending frivolously. You have to be strong during this time and suck it up. Just visualize your goal and how much better it will be when you achieve it. Another thing you can do is to actually carry cash. So give yourself a stipend each pay check of X amount and once that is gone its gone until next paycheck. This will make you more conscious of what you are spending and be a little tighter with your hard earned money until you get thing under control financially.
When tackling multiple debts you should either pay off the lowest total first or the highest interest rate. Then when one is paid off use that payment to snowball into the other, this method is called the Snowball method which again, Dave Ramsey recommends and I have read that is the most effective way of paying off debt. I would also say that you want to first pay off credit cards then work on installment debt, which are student loans, car loans, and the mortgage (debts that have a term). The latter three will not necessarily hurt your credit, unless you are behind on paying them, then that is a major problem. The reason to pay off credit cards first is because they generally have higher rates and the credit card companies have the ability to increase the rates even higher. With an installment loan this will not happen unless you have an exotic mortgage such as an adjustable rate, known as a 3 or 5 year ARM (3 year Adjustable Rate Mortgage). That means that for the first three years the rate is fixed then it adjust every year based on the market rate, if you can avoid it do not get one of those when buying a house. For revolving debt this is not always the case as just paying the minimum can get you into trouble, as this is just to cover the interest, nothing is going towards the principle, so the balance never really goes down. Something else to keep in mind is to stay away from adjustable rate mortgages, unless you know what the market will look like in 3 to 5 years and are comfortable with that.
Let’s talk a little about installment type loans. An installment loan is a loan that has a fixed payment, fixed interest rate, and a fixed term. So as long as you pay the payment every month, the loan will be paid off in the allotted time. With an installment loan a portion of your payment will always go to the principle, it may be small but every little bit helps. Gradually the portion that goes toward the principle will increase over time. The banks get their money first so at first 70% or so of your payment will be paying the interest, but toward the end you will be paying little to no interest. That may not be the case with a credit card or revolving dept. Installment type debt will not necessarily hurt your credit unless you are behind on paying it. So again for the love of God do not get behind on your mortgage. Getting behind on your mortgage will crush your credit. If you have to choose between paying other bills or your mortgage, always, always, always, pay your mortgage. So if you can avoid it stay away from large amounts of revolving debt, installment debt is better, but make sure you do not get behind paying either.
When applying for a mortgage you need to do some research about what it will take. I am not sure if 20% is still needed, but banks have tightened up their criteria. Still shop around call a bank and ask what is needed, also see if there are any grants or anything that you can qualify for. Personally if the bank only wants 5% down then I would only give them 5%, I would not give them any more of my cash to begin with than they need. Why give up more of your cash than you have to, especially being a first time home buyer. Hang on to your cash if you can. If you can put down 20% and still have a few thousand dollars cash in hand then by all means go ahead, but I would still feel more comfortable hanging on to my cash, but that is just me. Also you may have to pay Private Mortgage Insurance (PMI), do everything in your power to avoid paying this, it is a waste. This is basically a way for the bank to cover its ass if new borrowers default on their loans. This money does not go toward your principle and can add a hundreds of dollars to your payment.
Dave Ramsey says that you should pay down all debt, including your mortgage, as fast as possible. I do not totally agree with this. Your mortgage will probably be around 3% to 4% rate. That is about as low as you can get no matter your credit score. So you have to think of spending all your extra money paying that off versus that extra money earning 5% to 7% in the market for 30 plus years. I would say that if your mortgage is your only debt then you could put a few extra dollars toward it, but I do not think the mortgage is that big of a liability. If you have a higher rate then I would certainly pay it down and refinance to get a better rate. However, I am still not a fan of putting all your money toward paying off your house. But if that is your goal then go for it.
Also stay away from exotic mortgages and have some common sense about what you can afford in a house payment. If you make $30K a year you probably afford a $200K house. Now the bank may try and convince you otherwise, but again you have your almighty budget and know what you can afford. Also if the bank says that you can afford this house ask them how much of the payment is going to the principle. I bet they will say none almost none, you do not want that loan or house, and that scenario is exactly what happened back in 2008. Just something to keep in mind.
So after you have your plan in action and working, life will happen and you have to adjust your plan that is certainly fine as well. But remember you have a little cushion of $1,000 as well to help if need be.
Paying off debts takes discipline, that is the most important aspect when it comes to achieving your financial goal, DISCIPLINE. It is also important to understand what you can and cannot afford. Do not live beyond your means especially when trying to pay down debts. On the flip side that does not mean that you cannot have fun, just that you may have to choose between a night out with friends and eating out lunch that week, this is where carrying cash can come in handy. Again just be disciplined.
Here is a little scenario. Let’s you are on the verge of being debt free of let’s say $5K in student loans and $5K in credit card debt. So nothing crazy just still a thorn in your side. (The aver age American has over $4K in credit card debt.) This is where Dave Ramsey and I differ on what to do, and never ever underestimate the power of compounding interest, which I will get into later in my next post. If the credit card is a high interest rate I would focus all my efforts on paying that down, BUT if you have decent or even excellent credit I would transfer that 5K balance to a 0% interest card for the time being. If you are unable to do that then again all effort needs to be made to pay the credit card off quickly as you are paying a ton in interest, probably over 15%. If you are able to do a balance transfer then look at what you can afford to pay and pay that, those dollars will go directly toward the principle interest free. On $5K balance the minimum payment for the card will be like $65 on a 0% interest card and that money is going straight toward the principle. A $5K balance on a 15% card will cost you about $189 or so. So you can cut that payment down and save almost $130 per month. Or you can keep paying your original payment and have that card paid off in no time.
If you choose to only pay $65 a month, take that extra $130 and work on paying down your student loan as you are still paying interest on that. You should potentially be able to pay off your student loan with a balance of less than $7K in the year, depending on income, with the additional $130 dollars you are saving on the credit card. Then at the end of 2017 you will have one debt paid off and only $3,800 or so left on the credit card, and I would just do another balance transfer and get another 0% card and continue to pay it down. (Some cards offer as many as 21 months of 0% on balance transfers.) Or transfer the balance and use the Snowball method and pay this one off too. Remember your credit score will probably have improved because you paid off one of your loans so getting another 0% card will be no problem. You will pay a onetime 3% transfer fee, but this is much less than the interest rate you were paying to begin with. This is just a strategy I like, but it is certainly not the only one. The only issue with this is that you will need to have pretty decent credit to do this.
This method is using the system for your benefit. Transferring balances is a great way to skirt paying high interest rates. If you do not have good enough credit to get a 0% card, I would try to work out a deal with your current card company and get the rate lowered. If you accomplish this keep paying your original amount, and for the love of GOD stop using that credit card! It is also important to state that having a lot of credit does not mean you have bad credit. Not paying your bills will get you a bad credit score. Also maxing out your cards and applying for credit will also effect your credit score negatively. You should check your score at least once a year, and only apply for credit no more than 3 times a year. But honestly a few more than that will not hurt your score that much, unless you have five credit pulls in a few months. Remember this when applying for a mortgage. Do not let every bank you talk to pull your credit. You should have an idea of you score and then ask the bank what the rate is for someone with a 730 credit score. They will ask you what you make along with any other outstanding debt. You can give them a ball park or specifics and they should be able to tell you a general rate and some additional terms of their loan.
If you are unable to transfer the balance, again I would focus all my efforts on paying down the balance on the credit card. I would also try to make bi-monthly payments. Basically every time you get paid, you pay your bills too. Again this is where your budget will come in handy and you can try and squeeze every dollar out of your paycheck. Do not let dollars sit in your bank account, they are not helping you there. You should have almost no money in your account after your pay your bills. I know that sounds odd, but think about it, you have your bills paid, the rest saved in an interest bearing account and what is left you have invested in the market. You have your emergency fund of $1K, so why have an extra $100 sitting there in your checking account doing nothing? Take that and make an extra payment on your debt. This method will also potentially curb any impulse you might have to spend that left over money. Seeing $0.00 in your checking is scary and will deter you from spending on things you don’t need.
Having good credit is important and I use to be a loan officer and those that needed it, didn’t have it, and those that had good credit didn’t need it. It was sad at times to see how poorly people had managed their money and the situations they were in. But again if you are DISCIPLINED this should not be a problem. I also know that life happens, but remember you have your emergency fund. If you have bad credit I recommend first getting a credit report and find out what is causing your bad credit. It could be a simple misunderstanding that can be cheaply rectified.
Now let’s say that in a few months you will have your debts paid off or mostly paid off and you suddenly have extra dollars laying around. Please resist the urge to go on a massive shopping spree, as that is what probably got you in this mess in the first place. Instead, invest that money! But what is the best way to invest? Where should I put my money? Just saying that word strikes fear in quite a lot of people. Fear not next time we will talk about some basic investing rules as well as automating your savings, to help and hopefully get you on the fast track to retirement.