Monthly Archives: March 2010

Should I Use Savings to Pay Off Credit Card Debt?

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Eric writes in with the following question about using savings to pay off credit cards:

I have about $2,000 on a credit card and I have about $5,000 saved for an emergency fund. Would you recommend taking out the two grand out of savings and paying off the card? I know that is probably a dumb question, but maybe I just need reassurance from a third party.

I should add that I own my own business and this year has started off worse than last year, so that is why I am a bit more nervous about taking it out of the savings. Also, what goes on the card are usually business expenses that really need to be bought. Kind of a difficult situation, and I think that I will just have to figure out how to not put anything on the card, and figure out how to lower my overhead in my business.

Eric, in just two paragraphs you’ve summed up a predicament many business owners find themselves in. Using your credit card to cover business expenses is not necessarily a bad thing, as long as revenues can cover those expenses, and allow you to pay off the card in full each month.

When your business credit card balance begins to grow, I start getting nervous because it is a very slippery slope to finding yourself deep in debt. It sounds like you are already looking for ways to reduce your expenses, and that is definitely a great first step.

In this scenario, I would not use savings to pay off the credit card, because it would wipe out 40% of your emergency fund. Instead, I would drastically reduce business expenses and use all business earnings over the next few months to eliminate your credit card balance. You may pay a little more interest, but preserving your emergency fund should be a priority in tough times.

In the mean time, I would consider moving to a cash-basis for purchasing supplies – even if you had to set aside $1,000 or so from your emergency fund as a buffer in your business checking account. Once the credit card is paid off, continue to keep expenses low and build up a business emergency fund representing six months of business expenses. Keep this money separate from your personal emergency fund (which should represent 6 months of personal/household expenses). Think of it as your own business line of credit for lean times.

With your business emergency fund in place, and your credit card debt paid off, you’ll be in a much better position to resume investing in your business again. If you decide to resume making purchases with your credit card, be sure to pay off the balance in full, and stop using it immediately if revenues drop off and you are unable to pay the card balance.

I hope things improve and you are able to hang on to your business. As an entrepreneur myself, I am well aware of the passion and energy business owners pour into their endeavor. Sometimes that dedication blinds us to the fact our business isn’t doing too hot, and we look for creative ways to keep it funded (such as turning to credit cards, home equity and small business loans). I admire you for tackling your debt before it became a big problem, and I suspect you can clean this up rather quickly and move on to enjoy future success.

Ask the Reader: What additional advice do you have for Eric? Do you agree or disagree with the advice I gave?

March Madness Reminds There Are No Cinderellas

Posted on by  at  5:00 am
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With NCAA College Basketball’s March Madness in full swing, and Northern Iowa’s ousting of number one seed Kansas over the weekend, I thought a post about “Cinderellas” would be particularly appropriate. I’m not referring to the Cinderella, the step-daughter turned Disney princess. I am referring to a dark-horse team, usually from a small conference, that knocks off the top seeds to make a run at the Final Four.

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Photo by Stu Seeger

There are No Cinderellas

I would argue that there is no such thing as a Cinderella team. The label is frequently used to slight their accomplishments by insinuating “they got lucky.” Sometimes luck plays a part in it, but most Cinderellas pull off the upset because they out-worked, out-hustled, out-coached, and out-played their opponent. The pinnacle moment in their sports careers comes as a result of hours of preparation, workouts, practice, and film study.

How does this apply to finances? Many of the wealthiest people in our country are also some of the most envied. Sure, we all would like to be Bill Gates for a day, but why do so many people speak ill of successful people like Gates? Is it jealousy? Or is it the realization that they don’t have the fortitude, the work ethic, the determination to be as successful as those in the wealthy class.

“Well it is easy to build wealth if you receive an inheritance.” Believe it or not, most millionaires are self-made, first-generation rich. They do not stand to inherit a large sum of money like Paris Hilton. They did not strike it rich in the lottery, or win a giant lawsuit. They worked every single day for many, many years at their craft. They built multi-million dollar businesses from card tables in their garages or dorm rooms.

They led large corporations of hundreds of employees. They spent hundreds of hours writing, editing and marketing their book ideas to anyone who would listen. These self-made millionaires did not become overnight successes.

How to Become a Financial “Cinderella?”

  • Get out of debt. Carrying around debt is like trying to climb Mt. Everest with a hundred pound weight tied to your back. It is just impossible to become a financial success while carrying around debt.
  • Don’t mortgage away your future. When you get pre-approved for a mortgage your lender will likely provide a maximum mortgage that’s way out of your price range. Ignore their number. I personally wouldn’t tie up more than 20% of my take-home pay in housing. Doing so would mean less to save and invest, and that’s a trade off I’m not willing to make to enjoy a little extra square footage.
  • Stop trying to impress strangers at a red light. The average new car payment in America is approaching $500 a month. Sell that sporty new car, buy an older, reliable, used car with cash and drive it until the wheels fall off. Keep driving used cars the remainder of your life and deposit that $500 into a mutual fund every single month. In thirty years you will become a millionaire.
  • Turn off the television and read to learn something. Knowing the last five winners of American Idol won’t make you a success. Studying the habits of highly successful people will.
  • Practice frugality in all areas of your life. Buy clothes on sale; and only when you need them. Avoid paying for name brands when quality alternatives, or homemade solutions, exist. Be a frugal grocery shopper. Eat at home; it is healthier and less expensive. Invest in yourself; you will live longer and pay less for it in medical bills and insurance premiums.

Finally, after a couple decades of sacrifice, determination, and dedication you could become an overnight success, and be called a financial “Cinderella” yourself.

*This post appeared in the Carnival of Personal Finance – Blogthority.com Relaunch Edition

Postpone College In Order to Pay For It With Cash?

Posted on by  at  6:00 am
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This article is by Adam from Money Relationship. Subscribe to his site to get free updates on his journey out of debt.

One of my biggest financial regrets was taking out student loans for college. My wife and I currently have about $110,000 left to go on our loans and frankly, that number is hard to look at. I know for a fact that I could have graduated with $0 in student loans but I was just stupid with my money. I had great jobs throughout college but instead of using my money towards school, I used it for other useless junk.

I imagine many of you did exactly what I am about to tell you. Every semester, after the financial aid office received my Stafford loan disbursement, it was always for more than I owed the school. So of course, they cut me a check for the difference. Instead of using that money to pay off the loan (because I obviously didn’t NEED the money), I blew it on stuff that I can’t even remember. It was something that I always looked forward to every semester because it felt like free money. I thought to myself, don’t worry about it, you’re going to get a great job when you graduate and you’ll be able to pay it off in no time! Well, after 6 years of doing it (undergraduate and graduate), it added up. Now I’m stuck paying over $600 a month just for my loans. Oh, and I’m not even working in the field I got my degrees in!

Postpone College Until You Get Enough Cash?

Looking back, I know I could have paid for my first year of college with money from high school jobs. Well, what if you didn’t have a high school job and your parents didn’t save anything for your college? Should you wait a year until you get that money saved up? Personally, I think that it’s best to pay cash from the beginning. If you don’t have enough cash to start school then get a job to help pay for it. At least it will force you to get out in the real world and get some experience being an adult. That can be invaluable.

In addition to getting a job, you should also be looking for scholarships a couple of hours a day. Apply to as many as possible. The majority of them will probably reject you but I bet you will get a least a couple. Just think, the more scholarships you get, the less physical work you have to do!

You’ll Learn More By Paying in Cash

Another benefit to paying in cash is how it almost forces you to learn more. I have taken several classes that I paid cash for and I studied a lot more because I didn’t want to pay for it again. When I took classes using loan money, I slacked a little more. I’m not sure why, but I just knew I wouldn’t feel the financial pain as much if I had to take the class again (I never had to take a class a second time).

What do you think? Should you go straight to college even if it means taking out student loans?

How Much Should You Have In Your Checking Account?

Posted on by  at  6:00 am
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How much cushion do you like to leave in your checking account? You know, the money you try to balance down to instead of zero. In the past, I have simply tried to keep a few hundred dollars in my checking account to avoid overdraft fees.

I’ve recently discovered the beauty of declaring a specific amount in checking as the equivalent of zero, and basing our budget on that amount. For instance, if $500 feels like a comfortable cushion for you, then you should save $500 in your checking account and do not spend below this amount.

If at the end of the month your balance is $528.31, then move $28.31 to your savings account and start with exactly $500.00 as your balance heading into the next month. It’s a quick way to see how successfully you are budgeting without worrying about dropping below zero.

The Frugal Roundup

How I Ruined My Credit Score, and How It Didn’t Ruin My Life. If you haven’t heard, J.D. from Get Rich Slowly is featuring reader stories every Sunday. I really enjoy reading them and this particular one was a great story. (@Get Rich Slowly)

Frugality On a Whole New Level. Here’s a quick article on taking frugality to the extreme. How extreme have you taken frugality? (@Budgets Are Sexy)

The Definitive Extended Warranty Litmus Test. Len Penzo created a nifty looking chart to help you decide if an extended warranty is worth it.  (@Len Penzo dot Com)

How to Apologize For an Error? Martyr Yourself. Here is an interesting approach to handling errors you may make at work or in life. (@Financial Samurai)

$365 a Year for Food. Think you could feed yourself on a dollar a day? Might be a stretch for even the most frugal of us. Then again, when broke you do what you have to do. (@Smart Spending)

Best of the Rest

Stick With Stocks Or Pay Off The Mortgage?

Posted on by  at  5:00 am
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One of the most frequent questions I see popping up these days is whether or not we should continue to invest in stocks, or pay off our mortgages early? There are many factors driving the urgency behind this question. The down economy, and endless talks of deficit spending, national debt, etc, seem to have awakened people from their personal debt slumber. Folks are finally making serious dents in their personal debt, and I think that is a good thing.

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Photo by sacks08

But what about mortgages? Real estate has been a pretty touchy subject as of late. Many people now find themselves underwater – owing more on their mortgage balance than their home is worth. Those not currently in a home have taken a much more cautious approach to home buying than just a couple years ago, when anyone who could scrape up closing costs and had a half-decent FICO score were jumping into jumbo mortgages they could ill-afford.

Now that we have seen real estate is not a sure thing when it comes to appreciation, and that the market can basically go nowhere in an entire decade, we are questioning some long-held assumptions about the world of finance. Maybe it doesn’t make since to keep a mortgage. Maybe paying off a mortgage early, and living debt free, is the ultimate hedge against what the future might hold. Maybe renting isn’t such a bad deal after all.

Using Investment Money to Pay Off Mortgage

I was recently asked by a friend if they should pay off their mortgage using $120k in taxable investment accounts. I asked him the opposite of that question. “If you owned your home free and clear would you take out a mortgage to put $120k in the stock market?” Naturally, he replied, “Of course not!” Same thing.

That question gets right to the heart of the matter: risk. Our society seems to be going through a pull back thanks in large part to the pains we’ve experienced after watching each other go on a credit binge. It goes beyond being frugal. People are downright scared. And for good reason.

Unemployment is still hovering around double digits (real unemployment is much higher). I read a new article every day about the coming bust in commercial real estate. The student loan program appears to be under strain (and might get overhauled along with the healthcare system). And will there be a double dip to this recession? There is a lot of uncertainty out there.

I often advise people to make paying off their mortgage a priority, once other financial goals such as retirement investing and saving for college are in place.  However, I’m going to go a step further. I believe, over the next decade, we are going to see some unprecedented shifts in the way our economy operates – some good, some bad.

I think those who are completely debt free will be the most insulated from the negative effects of the changes, and have the most opportunity to be successful. That doesn’t mean you’re doomed if you have a mortgage (at least I hope not, considering I still have one myself), but it does mean that finding a way to pay off your mortgage should be near the top of your financial priorities.

What About the Opportunity Costs Lost By Not Investing in the Market?

Well, assuming market values appreciate in the coming decade, there is a cost to paying off your mortgage rather than investing in stocks. However, if I asked you if you’d rather owe nothing on your home or have $150,000 in savings in ten years, which would you pick?

Not having a mortgage could mean living comfortably on $1,000 a month less (or more, depending on your home loan). With $150,000 in stocks, you are doing pretty good, but certainly no where near financial independence. And you’d still have that big mortgage payment to contend with.

In a perfect world we could do both: pay off the mortgage early and invest in the stock market. Unfortunately, most of us don’t have that many dollars to play with. So, the ideal compromise may be to save for retirement, save for college for your children, and then pay off the mortgage early, rather than invest in taxable investments outside of retirement accounts.

This is the plan I will adopt, with the exception of adding to my dividend stock portfolio over time in an effort to boost passive income.

*This post was included in the Carnival of Personal Finance #249 at Amateur Asset Allocator