The Net Worth Statement is a statement of your personal financial position at a given point in time. It is often referred to a snapshot because it gives you a fairly clear picture of your financial position at that moment by analyzing your assets less your liabilities. The statement does not reveal how your personal financial position became what it is nor does it determine where it will be in the future. For this information, you need to prepare and review your income and expense statement for past financial information and budget statement for future expectations.
The Net Worth Statement is generally divided into three items: assets, liabilities and net worth.
Assets. Assets are generally divided into two groups — short-term assets and long-term assets. They are usually presented in order of liquidity, with short-term assets (cash and marketable securities) appearing first followed by long-term assets. Here is an illustration of the asset side of the Net Worth Statement:
Cash: $
Cash on Hand
Checking Accounts
Savings Accounts
Certificates of Deposit
Loans/Accounts Receivable
Investments:
Money Market Accounts
Stocks
Mutual Funds
Bonds
IRA/Retirement Funds
Other
Real Estate:
Personal Residence
Other
Personal Property:
Automobiles
Furniture
Jewelry
Other personal property
TOTAL ASSETS
Liabilities: Liabilities are presented in order of the nature of the claim in a manner similar to assets. Debts that are due within a short period of time such as credit card debt and other personal debt are listed first followed by auto loans, big-ticket loans, and last mortgage debt. The liability side of the Net Worth Statement looks something like this:
Current Bills: $
Credit Card Debt
Personal Loans
Medical Expenses Due
Other
Loans Payable:
Bank Notes
Home Equity Loans
Auto Loans
Big-ticket loans (furniture/appliances)
Income Tax Payable
Other
Long Term Notes Payable:
Mortgage Loans
Other
TOTAL LIABILITIES
To determine your total personal net worth, subtract your total liabilities from your total assets.
Total Assets $
Less: Total Liabilities
TOTAL PERSONAL NET WORTH $
What do these net worth results mean? Consider it a gage at how much you have borrowed in order to accumulate the assets that you own. In a perfect scenario, you will accumulate assets without borrowing. The two most basic ways to do this are to invest in assets that appreciate over time such as equities (stocks and mutual funds) and real estate and to save some of what you earn. More important than your actual net worth is having a starting point from which you can track your future accumulation of wealth. By understanding your present situation, you can build a plan that drives you to fulfill your financial goals.
AVOID THIS TRAP: Keep in mind that your net worth statement is useful only to you and your own personal situation and objectives. Many people try to measure their own financial success by comparing to the perceived success or failures of friends, neighbors, or others. Don’t do this. It will neither change your situation or theirs. Just because a neighbor purchased an expensive car or broke ground on a new addition to their house doesn’t mean that they are either a financial success or failure.
If you want to compare with macro-based data, the Federal Reserve Board conducts a periodic survey of consumer finances. In its latest survey, the median family net worth for various age groups were as follows (in thousands): Less than 35 years old - $14.2; ages 36 – 44 – $69.4; ages 45 – 54 - $144.7; ages 55 – 64 - $248.7; ages 65 – 74 - $190.1; and ages 75 and over - $163.1.
Be on alert if your net worth is negative or if your available cash does not provide enough money to sustain you for three to six months without income. Don’t panic if this is your situation, but do take action to develop an emergency cash fund. Make this your top priority!
As a second priority, put together a plan to get rid of your debts, focusing on the highest interest rate items first.
Thursday, March 12, 2009
Monday, March 9, 2009
The Basics: Debt Reduction Plan
Start your debt management and reduction plan by first understanding your current situation. You need to get your financial records organized and start a budget. This debt reduction plan will obviously be a core component to your budget. If you have not done this already, you can find helpful information at http://www.personalfinancesage.com/.
How much Debt Can You Afford?
Many lenders and financial advisors cite common ratios such as the front-end ratio and back-end ratio in determining a healthy level of debt exposure for your personal financial situation. While these are generally helpful tools, they do not replace the simple fact of how much income you receive compared to how much you spend keeping in mind how much you need to save in order to achieve your goals. The best way to be specific about these items is to prepare and review your budget or similar cash flow statement. In any event, because the front-end and back-end ratios are commonly cited in obtaining loans, a brief explanation of each is provided here:
Front-end ratio: The front-end ratio is your total monthly housing cost divided by your gross monthly income. This total housing cost includes the principal, interest, taxes, and insurance related to the monthly payment of the housing. The “rule of thumb” is that your monthly front-end ratio should not exceed 28 percent.
Back-end ratio: The back-end ratio is your total monthly housing costs as defined above plus all of your other monthly debts. Other monthly debts include auto loans, credit card payments, personal loans, student loans, and other personal debt. The “rule of thumb” with the back-end ratio is that it should not exceed 36 percent.
The theory with these ratios is that up to 36 percent of your gross monthly income will be made up of housing costs and debt payments, another 25 to 30 percent of your gross monthly income will be allocated to income and Social Security taxes, leaving the remaining amount to use for household expenses and savings.
What are your debt ratios? See the table below to input your own information:
PERSONAL DEBT RATIO CALCULATIONS
Front-end Ratio – 28% guideline:
Total monthly housing expenses * $____________
Divided by
Total monthly gross income $____________
Result ____________%
Back-end Ratio – 36% guideline:
Total monthly housing expenses * $____________
Add monthly debt payments ** $____________
Total combined monthly payments $____________
Divided by
Total monthly gross income $____________
Result _____________%
* figure should include monthly principal, interest, taxes and insurance
** figure should include auto loans, credit card payments, personal loans, and student loans
One nuance to this type of evaluation is not taking into consideration your particular savings goals. For instance, if you are closer to retirement and have not saved enough money for this purpose, you may need to increase your monthly savings. Given this added monthly savings allocation the standard front-end/back-end guidelines may not be a complete enough analysis of your debt position. Again, you should refer to your budget for specific details on your particular loan affordability. In another situation, you may be young, borrowing well within the guidelines given above, and saving on a regular basis in an amount that will satisfy your financial goals. In this scenario, the ratio guidelines are helpful and appropriate. The point here is that these ratios are guidelines and not specific conclusions as to whether or not you should take on a loan or whether or not your current debt levels are appropriate for your situation. If you complete the table above and find that you are already in breach of the guidelines, you should pay particular attention to the next section on Debt Reduction.
Debt Reduction Plan:
Many people have too much debt. Reasons can vary from the loss of a job, unexpected expense, divorce, medical condition, loss of family member, or simply living a life of unhealthy and excessive spending habits. If you have too much debt, you may fall into one of these categories. The good news is that for most people, there is a solution. It will require understanding of your situation, development of a plan, and action. And the action may not be easy. As you go through the process, the act of doing something about your situation will hopefully provide you with some relief from anxiety.
Let’s start the process. First create a debt schedule by listing all of your debt by name, interest rate, minimum monthly payment amount, past due amount, and total amount due. Include all credit card debt, personal loans, medical loans, student loans, home equity lines of credit (but not your primary mortgage loan) and any other personal debt. Be sure to keep in mind the amount of early termination feesthat may be owed by termination or paying off the debt early. Second, arrange the debt in the order of highest interest rate first. Then input the amount of money you have available to make such debt payments each month from your budget. The surplus or deficit will let you know what action you need to take at this point.
Complete your schedule and totald up the columns. If you have money leftover each month then that is the money you can use for other purposes such as savings. If you have a deficit, you need to start developing a plan to reduce your debt. Here are some things you should consider in reducing your debt:
Past Due Payments: In order to preserve your credit status, you should tackle any past due payments first. The negative effects of late payments include lower credit scores, higher interest rates, and expensive late fees. Once you are up to date with all of your credit cards and loans you can move on to devising a strategy for selecting which debts to pay next.
Eliminate Payday Loans: If you are in the payday loan trap, get out of it. The interest on those loans is extremely high and until you stop relying on these advances, you will have difficulty in repaying your other debts.
Which Loans to Pay Down First: Once you are current on all of your debts, target the high interest bearing credit cards and loans. Make an additional payment on the credit card or loan with the highest interest rate in order to pay it off first. When you have completely repaid this loan, move to the next highest interest rate bearing loan, and so on.
CAUTION: Remember to pay at least the minimum monthly payment due on all of your loans and keep them current. You will not do yourself any good by aggressively paying down the high rate loans while avoiding payment on others. This will negatively affect your credit.
You may want to consider other factors in deciding which loans to pay off first other than high interest. For instance, if you are more concerned with your credit score, you may want to target credit cards that are at the maximum limit. A high debt balance compared to the credit limit can hurt your credit score. A rule of thumb is to keep your credit card balances at less than 30 percent of the total available credit amount.
Use your Savings to Repay Debt: If you have $100.00 in a savings account earning you 5% per year (about 3% after tax) and a $100.00 credit card balance with an 18% interest rate per year, you would be smart to pull the money out of savings and pay off the credit card balance. This is the general theme in using savings to repay debt.
Exceptions: There are of course exceptions to this thought.
1. First of all, if you don’t have an emergency savings fund (usually three to six months worth of income) you should keep your debts current and build this emergency savings. Make this your highest priority.
2. Another exception is investing for retirement through a company sponsored retirement account. Because company sponsored retirement plans can offer matching amounts up to certain limits, your ultimate return on your investment will likely be more by investing in this type of plan. If you invest $100.00 in such a retirement plan and your employer has a 50% matching plan you have already made $50.00 on your investment.
3. If your savings is held in a certificate of deposit (CD) or other investment where a termination penalty fee is due for early withdrawal, you won’t get the same interest advantage. If on the other hand you are behind on your monthly debt payments, paying an early withdrawal penalty may be worth saving your credit rating.
Other Ways To Get Help:
1. Apply for a lower interest rate credit card and transfer higher interest balances. One resource to search the market for available credit card deals is CardWeb.com (http://www.cardweb.com/). Don’t forget to cancel and cut up the high interest credit card once you have paid it off!
2. Contact the high interest rate credit card or loan provider and try to negotiate a lower rate. If you let them know they risk losing you as a customer and that you are shopping around for a more favorable credit card, they may give you a better rate. Keep in mind that credit card companies make money from merchants where you use your cards in addition to your interest payments.
3. Contact your credit card bank or other lender and talk with them about alternative payment arrangements. You may think that this is a hopeless cause, but it is not. If you are at a point of being late or skipping payments, you owe it to yourself to at least try it. If you are successful in getting some relief be sure to follow up on your promise to pay under the alternative payment plan. Not doing so will almost assure you of future problems with your lender.
Credit Counseling Agencies:
With the increase of people in need of help with debt restructuring, many are turning to credit counseling agencies. These agencies promise debt relief and avoidance of bankruptcy. Some agencies may deliver these results, but many others do not. Complaints of these agencies include the inability to deliver on the promise of debt restructuring resulting in tarnished credit ratings.
Many credit counseling agencies offer debt management programs where they negotiate monthly payment plans with your creditors and collect a monthly fee from you for handling the payments. The problem with this scenario is that the agency makes money on you only if you are in their debt management program. This isn’t much incentive for them to help you out of debt. You should strongly consider avoiding these types of programs.
The conclusion that can be drawn from this should not be to avoid these types of agencies altogether but to use caution when selecting a firm. Here are some questions to consider:
- How long have you been in business?
- How long have you been working for the agency? The longevity should be a strong factor in considering which one to choose.
- What are your specific qualifications? Remember to work with an individual and not a group. In doing this you will want to know the qualifications of the person you are dealing with. If you are talking to a sales person, move past them and evaluate the credit counselor.
- Client references – ask for references of the counselor and call them. You want to establish the quality of the counselor you will be dealing with and not just the agency.
- What are your fees and costs? Get this in writing and be sure not to gloss over the fine print. You should also get a blank copy of any agreements you will be asked to sign and review them.
- What licensing is required in your area?
- Are you (credit counselor) in compliance with the requirements?
- How are you (credit counselor) paid? Make sure there is no conflict of interest in the way they are paid such as with debt management programs.
- What is your privacy policy? Understand any information sharing that they may practice.
Some helpful resources in finding credit counseling agencies can be found at the National Foundation for Credit Counseling website at http://www.nfcc.org/. Anther helpful site is the Federal Trade Commission’s website at http://www.ftc.gov/.
How much Debt Can You Afford?
Many lenders and financial advisors cite common ratios such as the front-end ratio and back-end ratio in determining a healthy level of debt exposure for your personal financial situation. While these are generally helpful tools, they do not replace the simple fact of how much income you receive compared to how much you spend keeping in mind how much you need to save in order to achieve your goals. The best way to be specific about these items is to prepare and review your budget or similar cash flow statement. In any event, because the front-end and back-end ratios are commonly cited in obtaining loans, a brief explanation of each is provided here:
Front-end ratio: The front-end ratio is your total monthly housing cost divided by your gross monthly income. This total housing cost includes the principal, interest, taxes, and insurance related to the monthly payment of the housing. The “rule of thumb” is that your monthly front-end ratio should not exceed 28 percent.
Back-end ratio: The back-end ratio is your total monthly housing costs as defined above plus all of your other monthly debts. Other monthly debts include auto loans, credit card payments, personal loans, student loans, and other personal debt. The “rule of thumb” with the back-end ratio is that it should not exceed 36 percent.
The theory with these ratios is that up to 36 percent of your gross monthly income will be made up of housing costs and debt payments, another 25 to 30 percent of your gross monthly income will be allocated to income and Social Security taxes, leaving the remaining amount to use for household expenses and savings.
What are your debt ratios? See the table below to input your own information:
PERSONAL DEBT RATIO CALCULATIONS
Front-end Ratio – 28% guideline:
Total monthly housing expenses * $____________
Divided by
Total monthly gross income $____________
Result ____________%
Back-end Ratio – 36% guideline:
Total monthly housing expenses * $____________
Add monthly debt payments ** $____________
Total combined monthly payments $____________
Divided by
Total monthly gross income $____________
Result _____________%
* figure should include monthly principal, interest, taxes and insurance
** figure should include auto loans, credit card payments, personal loans, and student loans
One nuance to this type of evaluation is not taking into consideration your particular savings goals. For instance, if you are closer to retirement and have not saved enough money for this purpose, you may need to increase your monthly savings. Given this added monthly savings allocation the standard front-end/back-end guidelines may not be a complete enough analysis of your debt position. Again, you should refer to your budget for specific details on your particular loan affordability. In another situation, you may be young, borrowing well within the guidelines given above, and saving on a regular basis in an amount that will satisfy your financial goals. In this scenario, the ratio guidelines are helpful and appropriate. The point here is that these ratios are guidelines and not specific conclusions as to whether or not you should take on a loan or whether or not your current debt levels are appropriate for your situation. If you complete the table above and find that you are already in breach of the guidelines, you should pay particular attention to the next section on Debt Reduction.
Debt Reduction Plan:
Many people have too much debt. Reasons can vary from the loss of a job, unexpected expense, divorce, medical condition, loss of family member, or simply living a life of unhealthy and excessive spending habits. If you have too much debt, you may fall into one of these categories. The good news is that for most people, there is a solution. It will require understanding of your situation, development of a plan, and action. And the action may not be easy. As you go through the process, the act of doing something about your situation will hopefully provide you with some relief from anxiety.
Let’s start the process. First create a debt schedule by listing all of your debt by name, interest rate, minimum monthly payment amount, past due amount, and total amount due. Include all credit card debt, personal loans, medical loans, student loans, home equity lines of credit (but not your primary mortgage loan) and any other personal debt. Be sure to keep in mind the amount of early termination feesthat may be owed by termination or paying off the debt early. Second, arrange the debt in the order of highest interest rate first. Then input the amount of money you have available to make such debt payments each month from your budget. The surplus or deficit will let you know what action you need to take at this point.
Complete your schedule and totald up the columns. If you have money leftover each month then that is the money you can use for other purposes such as savings. If you have a deficit, you need to start developing a plan to reduce your debt. Here are some things you should consider in reducing your debt:
Past Due Payments: In order to preserve your credit status, you should tackle any past due payments first. The negative effects of late payments include lower credit scores, higher interest rates, and expensive late fees. Once you are up to date with all of your credit cards and loans you can move on to devising a strategy for selecting which debts to pay next.
Eliminate Payday Loans: If you are in the payday loan trap, get out of it. The interest on those loans is extremely high and until you stop relying on these advances, you will have difficulty in repaying your other debts.
Which Loans to Pay Down First: Once you are current on all of your debts, target the high interest bearing credit cards and loans. Make an additional payment on the credit card or loan with the highest interest rate in order to pay it off first. When you have completely repaid this loan, move to the next highest interest rate bearing loan, and so on.
CAUTION: Remember to pay at least the minimum monthly payment due on all of your loans and keep them current. You will not do yourself any good by aggressively paying down the high rate loans while avoiding payment on others. This will negatively affect your credit.
You may want to consider other factors in deciding which loans to pay off first other than high interest. For instance, if you are more concerned with your credit score, you may want to target credit cards that are at the maximum limit. A high debt balance compared to the credit limit can hurt your credit score. A rule of thumb is to keep your credit card balances at less than 30 percent of the total available credit amount.
Use your Savings to Repay Debt: If you have $100.00 in a savings account earning you 5% per year (about 3% after tax) and a $100.00 credit card balance with an 18% interest rate per year, you would be smart to pull the money out of savings and pay off the credit card balance. This is the general theme in using savings to repay debt.
Exceptions: There are of course exceptions to this thought.
1. First of all, if you don’t have an emergency savings fund (usually three to six months worth of income) you should keep your debts current and build this emergency savings. Make this your highest priority.
2. Another exception is investing for retirement through a company sponsored retirement account. Because company sponsored retirement plans can offer matching amounts up to certain limits, your ultimate return on your investment will likely be more by investing in this type of plan. If you invest $100.00 in such a retirement plan and your employer has a 50% matching plan you have already made $50.00 on your investment.
3. If your savings is held in a certificate of deposit (CD) or other investment where a termination penalty fee is due for early withdrawal, you won’t get the same interest advantage. If on the other hand you are behind on your monthly debt payments, paying an early withdrawal penalty may be worth saving your credit rating.
Other Ways To Get Help:
1. Apply for a lower interest rate credit card and transfer higher interest balances. One resource to search the market for available credit card deals is CardWeb.com (http://www.cardweb.com/). Don’t forget to cancel and cut up the high interest credit card once you have paid it off!
2. Contact the high interest rate credit card or loan provider and try to negotiate a lower rate. If you let them know they risk losing you as a customer and that you are shopping around for a more favorable credit card, they may give you a better rate. Keep in mind that credit card companies make money from merchants where you use your cards in addition to your interest payments.
3. Contact your credit card bank or other lender and talk with them about alternative payment arrangements. You may think that this is a hopeless cause, but it is not. If you are at a point of being late or skipping payments, you owe it to yourself to at least try it. If you are successful in getting some relief be sure to follow up on your promise to pay under the alternative payment plan. Not doing so will almost assure you of future problems with your lender.
Credit Counseling Agencies:
With the increase of people in need of help with debt restructuring, many are turning to credit counseling agencies. These agencies promise debt relief and avoidance of bankruptcy. Some agencies may deliver these results, but many others do not. Complaints of these agencies include the inability to deliver on the promise of debt restructuring resulting in tarnished credit ratings.
Many credit counseling agencies offer debt management programs where they negotiate monthly payment plans with your creditors and collect a monthly fee from you for handling the payments. The problem with this scenario is that the agency makes money on you only if you are in their debt management program. This isn’t much incentive for them to help you out of debt. You should strongly consider avoiding these types of programs.
The conclusion that can be drawn from this should not be to avoid these types of agencies altogether but to use caution when selecting a firm. Here are some questions to consider:
- How long have you been in business?
- How long have you been working for the agency? The longevity should be a strong factor in considering which one to choose.
- What are your specific qualifications? Remember to work with an individual and not a group. In doing this you will want to know the qualifications of the person you are dealing with. If you are talking to a sales person, move past them and evaluate the credit counselor.
- Client references – ask for references of the counselor and call them. You want to establish the quality of the counselor you will be dealing with and not just the agency.
- What are your fees and costs? Get this in writing and be sure not to gloss over the fine print. You should also get a blank copy of any agreements you will be asked to sign and review them.
- What licensing is required in your area?
- Are you (credit counselor) in compliance with the requirements?
- How are you (credit counselor) paid? Make sure there is no conflict of interest in the way they are paid such as with debt management programs.
- What is your privacy policy? Understand any information sharing that they may practice.
Some helpful resources in finding credit counseling agencies can be found at the National Foundation for Credit Counseling website at http://www.nfcc.org/. Anther helpful site is the Federal Trade Commission’s website at http://www.ftc.gov/.
The Basics: How to be a Smart Borrower
Why should you be a smart borrower? Let's first talk about the potential effects of bad debt:
- Negative reports to credit reporting agencies resulting in a lower credit score. This in turn affects future access to credit and the terms of such credit including lower credit lines, higher interest rates, and faster repayment terms.
- Reduced access to future credit.
- Higher interest rates on loans.
- Lower credit lines.
- Accelerated repayment terms.
- Reduced ability to obtain business loans.
- Increased difficulty in renting a house or apartment.
- Increased anxiety and family stress.
- In some cases, your credit history can affect your ability to obtain certain jobs.
How You Can Be a Smart Borrower:
Complete your Budget: Visit the Budget Guide to get more information on the budgeting process. It is important that you avoid taking on too much debt. Set realistic spending and borrowing limits.
Understand your Rights: Understand your rights and responsibilities with respect to your credit and credit history. Three major laws – the Fair Credit Billing Act, the Fair Credit Reporting Act, and the Fair Debt Collection Practices Act – are designed to protect borrowers from unfair practices. For more information on these laws, visit the Federal Trade Commission website at www.ftc.gov/bcp/menus/consumer/credit.shtm.
Beware of Predatory Lenders: Many predatory lenders promote their services to people who may be financially distressed. Payday loan companies are notorious for this type of practice. Many payday loans carry effective interest costs that exceed amounts being borrowed. These types of loans are nearly impossible to repay in the long term. These types of lenders charge high rates of interest and use aggressive sales and collection tactics.
Don’t be Pressured: Never be pressured into acting quickly on any loan or offer for credit. You should employ the practice of walking away from a sales pitch in order to evaluate the offer privately. When it comes to credit, don’t assume that just because you are approved for a credit card or loan that it means that you can afford them. Your prospective lender may try to advise you on your ability to afford such loans. While they may be giving you good information, keep in mind that it is in their best interest to make you the loan and maybe not in your best interest to borrow from them based on your overall situation or long-term plans.
Understand your Loan Agreement: Make sure you understand all of the important points of your loan agreement. The most important points usually include:
• Total amount of the loan. Sometimes the amount you receive and the amount of the loan obligation are not the same amount. The difference can be additional fees charged.
• Is the loan secured by any assets?
• What is the monthly payment amount?
• Interest rate including the stated rate and annual percentage rate (APR).
• Are there any additional fees and costs associated with the loan?
• What is the term of loan?
• Is there a fee for early termination?
Use Caution in Borrowing Against Your Home: For things such as home improvement expenses that increase the value of your home, borrowing money secured by your house can be a good financial strategy. It allows you to align the amount of debt secured by your house with the value of the house. The interest cost may also be tax deductible. You still need to be sure that the amount of the expense is in line with your budgeted allocation for this type of monthly cost. Home loans with high interest rates, interest only payments, adjustable rates, negative amortization (reverse mortgage), and balloon payments, can be especially risky. Although these types of loans may make sense for your situation, use caution and seek professional assistance in obtaining advice on their use.
In most cases it is not a good idea to get a home loan to repay credit card debt. If you are considering a loan for this purpose, consult a financial professional first to evaluate your situation.
- Negative reports to credit reporting agencies resulting in a lower credit score. This in turn affects future access to credit and the terms of such credit including lower credit lines, higher interest rates, and faster repayment terms.
- Reduced access to future credit.
- Higher interest rates on loans.
- Lower credit lines.
- Accelerated repayment terms.
- Reduced ability to obtain business loans.
- Increased difficulty in renting a house or apartment.
- Increased anxiety and family stress.
- In some cases, your credit history can affect your ability to obtain certain jobs.
How You Can Be a Smart Borrower:
Complete your Budget: Visit the Budget Guide to get more information on the budgeting process. It is important that you avoid taking on too much debt. Set realistic spending and borrowing limits.
Understand your Rights: Understand your rights and responsibilities with respect to your credit and credit history. Three major laws – the Fair Credit Billing Act, the Fair Credit Reporting Act, and the Fair Debt Collection Practices Act – are designed to protect borrowers from unfair practices. For more information on these laws, visit the Federal Trade Commission website at www.ftc.gov/bcp/menus/consumer/credit.shtm.
Beware of Predatory Lenders: Many predatory lenders promote their services to people who may be financially distressed. Payday loan companies are notorious for this type of practice. Many payday loans carry effective interest costs that exceed amounts being borrowed. These types of loans are nearly impossible to repay in the long term. These types of lenders charge high rates of interest and use aggressive sales and collection tactics.
Don’t be Pressured: Never be pressured into acting quickly on any loan or offer for credit. You should employ the practice of walking away from a sales pitch in order to evaluate the offer privately. When it comes to credit, don’t assume that just because you are approved for a credit card or loan that it means that you can afford them. Your prospective lender may try to advise you on your ability to afford such loans. While they may be giving you good information, keep in mind that it is in their best interest to make you the loan and maybe not in your best interest to borrow from them based on your overall situation or long-term plans.
Understand your Loan Agreement: Make sure you understand all of the important points of your loan agreement. The most important points usually include:
• Total amount of the loan. Sometimes the amount you receive and the amount of the loan obligation are not the same amount. The difference can be additional fees charged.
• Is the loan secured by any assets?
• What is the monthly payment amount?
• Interest rate including the stated rate and annual percentage rate (APR).
• Are there any additional fees and costs associated with the loan?
• What is the term of loan?
• Is there a fee for early termination?
Use Caution in Borrowing Against Your Home: For things such as home improvement expenses that increase the value of your home, borrowing money secured by your house can be a good financial strategy. It allows you to align the amount of debt secured by your house with the value of the house. The interest cost may also be tax deductible. You still need to be sure that the amount of the expense is in line with your budgeted allocation for this type of monthly cost. Home loans with high interest rates, interest only payments, adjustable rates, negative amortization (reverse mortgage), and balloon payments, can be especially risky. Although these types of loans may make sense for your situation, use caution and seek professional assistance in obtaining advice on their use.
In most cases it is not a good idea to get a home loan to repay credit card debt. If you are considering a loan for this purpose, consult a financial professional first to evaluate your situation.
The Basics: Consumer Debt Trends
Consumer Debt Trends:
Getting into the problems and solutions of consumer debt, it is important to note a troubling trend. In the past several years, there has been a significant increase in the amount of debt incurred by consumers. The key drivers for this increase include:
- Mortgage lenders provided an overabundance of available credit as a direct result of the housing boom. Many mortgage lenders softened credit standards, ignored underwriting requirements, and issued home loans well in excess of healthy guidelines.
- Low mortgage interest rates.
- Surge in Internet shopping.
- Credit card companies have issued new credit or increased availability with credit cards. Many people (and businesses) have relied on this abundance of available credit to finance increasingly expensive lifestyles (or increasing business costs). As the credit markets tightened, this available credit has been significantly reduced and even eliminated for many borrowers.
Although many of these trends have recently reversed, the result of such practices should be no surprise with the recent and unprecedented number of foreclosures and bankruptcy filings.
Facts and Figures:
According to the U.S. Bureau of Economic Analysis, in 1980 U.S. consumer spending was 63% of the total Gross Domestic Product (The simple definition of GDP is the total market value of all goods and services produced within a country in a given period of time). This consumer spending recently increased to almost 71% of GDP. During the same time period the personal savings rate declined from 10% to nearly 0.5%.
Total U.S. consumer debt made up of home mortgages, auto loans, credit card debt, personal loans, and other personal debt is estimated to be $13.8 trillion.
Experian estimates:
The average individual U.S consumer debt (not including mortgage debt) to be $16,635.
One in six consumers with credit card debt only pays the minimum amount due each month.
MSN Money recently cited that approximately 43% of Americans spend more than they earn each year.
According to http://www.myfico.com/ average credit statistics are as follows:
Number of Credit Obligations - On average, today's consumer has a total of 13 credit obligations on record at a credit bureau. These include credit cards (such as department store charge cards, gas cards, or bank cards) and installment loans (auto loans, mortgage loans, student loans, etc.). Not included are savings and checking accounts (typically not reported to a credit bureau). Of these 13 credit obligations, 9 are likely to be credit cards and 4 are likely to be installment loans.
Past Payment Performance - On average, today's consumers are paying their bills on time. Less than half of all consumers have ever been reported as 30 or more days late on a payment. Only 3 out of 10 have ever been 60 or more days overdue on any credit obligation. 77% of all consumers have never had a loan or account that was 90+ days overdue, and less than 20% have ever had a loan or account closed by the lender due to default.
Credit Utilization - About 40% of credit card holders carry a balance of less than $1,000. About 15% are far less conservative in their use of credit cards and have total card balances in excess of $10,000. When we look at the total of all credit obligations combined (except mortgage loans), 48% of consumers carry less than $5,000 of debt. This includes all credit cards, lines of credit, and loans-everything but mortgages. Nearly 37% carry more than $10,000 of non-mortgage-related debt as reported to the credit bureaus.
Total Available Credit - The typical consumer has access to approximately $19,000 on all credit cards combined. More than half of all people with credit cards are using less than 30% of their total credit card limit. Just over 1 in 7 are using 80% or more of their credit card limit.
Length of Credit History - The average consumer's oldest obligation is 14 years old, indicating that he or she has been managing credit for some time. In fact, we found that 1 out of 4 consumers had credit histories of 20 years or longer. Only 1 in 20 consumers had credit histories shorter than 2 years.
Credit Inquiries - When someone applies for a loan or a new credit card account - in short, any time one applies for credit and a lender requests a copy of the credit report - this request is noted as an “inquiry” in the applicant's credit file. The average consumer has had only one inquiry on his or her accounts within the past year. Fewer than 6% had four or more inquiries resulting from a search for new credit.
Easy Credit:
Until around the middle of 2008, many credit card companies were aggressive and some were even considered predatory lenders (predatory lending is the practice of a lender deceptively convincing borrowers to agree to unfair and abusive loan terms or terms with a high likelyhood of not being satisfied). These practices allowed almost everyone access to credit card debt. They promised instant gratification and improved lifestyles. These promises certainly are supported by the statistics cited above with spending at a 20 year high and savings at a 20 year low.
While many people used credit card debt properly many did not resulting in “extreme” overspending. Those that did not found themselves using credit cards and other revolving credit to finance everyday expenses such as groceries, gas and other household expenses on top of unaffordable lifestyle expenses such as vacations, cars, furniture, appliances, and home remodels. Many people who abused this easy credit did not take into account the consequences of such overspending.
Getting into the problems and solutions of consumer debt, it is important to note a troubling trend. In the past several years, there has been a significant increase in the amount of debt incurred by consumers. The key drivers for this increase include:
- Mortgage lenders provided an overabundance of available credit as a direct result of the housing boom. Many mortgage lenders softened credit standards, ignored underwriting requirements, and issued home loans well in excess of healthy guidelines.
- Low mortgage interest rates.
- Surge in Internet shopping.
- Credit card companies have issued new credit or increased availability with credit cards. Many people (and businesses) have relied on this abundance of available credit to finance increasingly expensive lifestyles (or increasing business costs). As the credit markets tightened, this available credit has been significantly reduced and even eliminated for many borrowers.
Although many of these trends have recently reversed, the result of such practices should be no surprise with the recent and unprecedented number of foreclosures and bankruptcy filings.
Facts and Figures:
According to the U.S. Bureau of Economic Analysis, in 1980 U.S. consumer spending was 63% of the total Gross Domestic Product (The simple definition of GDP is the total market value of all goods and services produced within a country in a given period of time). This consumer spending recently increased to almost 71% of GDP. During the same time period the personal savings rate declined from 10% to nearly 0.5%.
Total U.S. consumer debt made up of home mortgages, auto loans, credit card debt, personal loans, and other personal debt is estimated to be $13.8 trillion.
Experian estimates:
The average individual U.S consumer debt (not including mortgage debt) to be $16,635.
One in six consumers with credit card debt only pays the minimum amount due each month.
MSN Money recently cited that approximately 43% of Americans spend more than they earn each year.
According to http://www.myfico.com/ average credit statistics are as follows:
Number of Credit Obligations - On average, today's consumer has a total of 13 credit obligations on record at a credit bureau. These include credit cards (such as department store charge cards, gas cards, or bank cards) and installment loans (auto loans, mortgage loans, student loans, etc.). Not included are savings and checking accounts (typically not reported to a credit bureau). Of these 13 credit obligations, 9 are likely to be credit cards and 4 are likely to be installment loans.
Past Payment Performance - On average, today's consumers are paying their bills on time. Less than half of all consumers have ever been reported as 30 or more days late on a payment. Only 3 out of 10 have ever been 60 or more days overdue on any credit obligation. 77% of all consumers have never had a loan or account that was 90+ days overdue, and less than 20% have ever had a loan or account closed by the lender due to default.
Credit Utilization - About 40% of credit card holders carry a balance of less than $1,000. About 15% are far less conservative in their use of credit cards and have total card balances in excess of $10,000. When we look at the total of all credit obligations combined (except mortgage loans), 48% of consumers carry less than $5,000 of debt. This includes all credit cards, lines of credit, and loans-everything but mortgages. Nearly 37% carry more than $10,000 of non-mortgage-related debt as reported to the credit bureaus.
Total Available Credit - The typical consumer has access to approximately $19,000 on all credit cards combined. More than half of all people with credit cards are using less than 30% of their total credit card limit. Just over 1 in 7 are using 80% or more of their credit card limit.
Length of Credit History - The average consumer's oldest obligation is 14 years old, indicating that he or she has been managing credit for some time. In fact, we found that 1 out of 4 consumers had credit histories of 20 years or longer. Only 1 in 20 consumers had credit histories shorter than 2 years.
Credit Inquiries - When someone applies for a loan or a new credit card account - in short, any time one applies for credit and a lender requests a copy of the credit report - this request is noted as an “inquiry” in the applicant's credit file. The average consumer has had only one inquiry on his or her accounts within the past year. Fewer than 6% had four or more inquiries resulting from a search for new credit.
Easy Credit:
Until around the middle of 2008, many credit card companies were aggressive and some were even considered predatory lenders (predatory lending is the practice of a lender deceptively convincing borrowers to agree to unfair and abusive loan terms or terms with a high likelyhood of not being satisfied). These practices allowed almost everyone access to credit card debt. They promised instant gratification and improved lifestyles. These promises certainly are supported by the statistics cited above with spending at a 20 year high and savings at a 20 year low.
While many people used credit card debt properly many did not resulting in “extreme” overspending. Those that did not found themselves using credit cards and other revolving credit to finance everyday expenses such as groceries, gas and other household expenses on top of unaffordable lifestyle expenses such as vacations, cars, furniture, appliances, and home remodels. Many people who abused this easy credit did not take into account the consequences of such overspending.
The Basics: Debt Education
Before you dive into the debt reduction process it is important to understand that there is debt that can be used for investing in the future (such as education or a business), debt that can be used for investing in appreciable assets (real estate), and debt that can be used for consumer spending. Although all debt can be dangerous if not structured and used properly, consumer debt can be particularly harmful to your financial health.
What is Consumer Credit:
Consumer credit consists of mortgage loans, auto loans, credit cards, store cards, and personal loans. Terms of these loan types vary based on the type of loan, your credit score and payment history, amount of credit offered, whether or not the loan is secured, and etc. These types of loans generally require making payments according to a schedule. Late or missed payments will usually incur higher interest rates, loss of benefits (such as with cash back and airline mileage points), and late reports to credit bureau companies. Generally if credit is not paid off within the specified period of time, interest and/or a late fee is charged on the outstanding balance. Repayment of credit along with the interest charge depends on the type of credit taken. The basic types of loans include:
Close-ended loans: These types of loans are known as installment loans. Close-ended loans include mortgage loans, auto loans, and student loans. The lender of these types of loans will typically grant a fixed loan amount, interest rate and monthly payment. Monthly payments are generally equal monthly installments made up of a principal reduction portion and an interest portion. In most cases with mortgage and auto loans, a down payment is required at the origination of the loan. Close-ended loans are not intended to be revolving credit loans and as such do not provide flexibility to you as a borrower. Keep in mind that these loans may be secured by the assets that are being financed. If this is the case, the asset may be repossessed in the event of non-payment of the applicable loan.
Open-ended loans: These types of loans are referred to as revolving credit loans. Credit cards and home equity loans are the most common examples of open-ended loans. Credit cards come in the form of bank credit cards such as American Express, Master Card, and Visa, retail charge cards such as department store cards and gas station cards, and entertainment cards such as Diners Club cards. Home equity loans generally have a credit limit that is secured by the borrower’s real estate. With revolving credit loans, you can borrow funds repeatedly up to your available credit limit. Repayment terms on credit cards are usually geared to the lowest amount necessary to pay the interest on the outstanding balance. Because of this, the principal balance of your credit card debt doesn’t get paid off for years and is constantly accumulating interest.
Secured or unsecured loans: Auto loans, home mortgage loans, home equity loans are examples of loans that are normally secured by the assets being financed. This simply means that the assets being purchased or financed are used as collateral for the underlying loans being granted. Credit cards and other non-real estate related revolving credit loans are generally not secured by collateral. All loans granted to you are done so with the expectation that you will repay them according to their terms. Regardless of whether or not the loans are secured, non-payment or late payment will almost certainly result in action taken by the credit grantor. Loans that are secured allow the credit grantor to repossess the asset in the event of a violation of the terms of the loan agreements.
When evaluating loans, make sure you clearly understand the type of loan and terms of repayment in order to determine whether or not they fit your goals and expectations.
Many people take on the burden of debt without fully understanding their conditions. Others take on debt and then their personal circumstances change due to things such as unemployment, divorce or the death of a family member. These circumstances may result in late payments or even default on debt. There are many resources that can help with situations such as these. Explore the following sections for some solutions to these issues.
What is Consumer Credit:
Consumer credit consists of mortgage loans, auto loans, credit cards, store cards, and personal loans. Terms of these loan types vary based on the type of loan, your credit score and payment history, amount of credit offered, whether or not the loan is secured, and etc. These types of loans generally require making payments according to a schedule. Late or missed payments will usually incur higher interest rates, loss of benefits (such as with cash back and airline mileage points), and late reports to credit bureau companies. Generally if credit is not paid off within the specified period of time, interest and/or a late fee is charged on the outstanding balance. Repayment of credit along with the interest charge depends on the type of credit taken. The basic types of loans include:
Close-ended loans: These types of loans are known as installment loans. Close-ended loans include mortgage loans, auto loans, and student loans. The lender of these types of loans will typically grant a fixed loan amount, interest rate and monthly payment. Monthly payments are generally equal monthly installments made up of a principal reduction portion and an interest portion. In most cases with mortgage and auto loans, a down payment is required at the origination of the loan. Close-ended loans are not intended to be revolving credit loans and as such do not provide flexibility to you as a borrower. Keep in mind that these loans may be secured by the assets that are being financed. If this is the case, the asset may be repossessed in the event of non-payment of the applicable loan.
Open-ended loans: These types of loans are referred to as revolving credit loans. Credit cards and home equity loans are the most common examples of open-ended loans. Credit cards come in the form of bank credit cards such as American Express, Master Card, and Visa, retail charge cards such as department store cards and gas station cards, and entertainment cards such as Diners Club cards. Home equity loans generally have a credit limit that is secured by the borrower’s real estate. With revolving credit loans, you can borrow funds repeatedly up to your available credit limit. Repayment terms on credit cards are usually geared to the lowest amount necessary to pay the interest on the outstanding balance. Because of this, the principal balance of your credit card debt doesn’t get paid off for years and is constantly accumulating interest.
Secured or unsecured loans: Auto loans, home mortgage loans, home equity loans are examples of loans that are normally secured by the assets being financed. This simply means that the assets being purchased or financed are used as collateral for the underlying loans being granted. Credit cards and other non-real estate related revolving credit loans are generally not secured by collateral. All loans granted to you are done so with the expectation that you will repay them according to their terms. Regardless of whether or not the loans are secured, non-payment or late payment will almost certainly result in action taken by the credit grantor. Loans that are secured allow the credit grantor to repossess the asset in the event of a violation of the terms of the loan agreements.
When evaluating loans, make sure you clearly understand the type of loan and terms of repayment in order to determine whether or not they fit your goals and expectations.
Many people take on the burden of debt without fully understanding their conditions. Others take on debt and then their personal circumstances change due to things such as unemployment, divorce or the death of a family member. These circumstances may result in late payments or even default on debt. There are many resources that can help with situations such as these. Explore the following sections for some solutions to these issues.
The Basics: Creating a Budget
Establishing and managing a personal household budget is an extremely important part of achieving your personal financial goals. A budget is also the most basic form of money management. Regardless of your income, a regularly managed budget will allow you to see your spending habits in relation to your income. This clarity will allow you to make changes to your spending habits in order to accumulate wealth at the pace necessary for you to accomplish the financial goals you set for yourself. Most people find that when they realize where they spend their money, saving or saving more is not that difficult.
There is no right or wrong way to budget your money so long as you remember that managing your finances is not a one-time activity but a lifelong commitment. The best budget is one that allows you to stay interested in keeping up with it. A simple budget process is described for you to use below.
What is a budget?
A budget is a written allocation of the financial resources you have available to you. Many people use software programs such as Quicken that can integrate the budgeting process with managing bank and credit card accounts. Other people track budgets on spreadsheets. It can be measured on any time frame basis such as daily, weekly, monthly, annually, and so on. Usually household budgets are prepared and tracked on a weekly or monthly basis. Some people even manage in accordance with daily expense allotments. However you choose to manage your budget manage it regularly. For the purposes of our illustration, we will use a monthly budget. An income and expense data worksheet is provided below.
Monthly Income Information: For the purposes of gathering data, it is recommended that you use a monthly format. You can prepare a budget from this information on a weekly or monthly basis depending on the level of discipline you want. Input the monthly information for each item in the list below. If necessary, use estimates in order to get the monthly amount.
Monthly Income:
Employer Income:
Salary / Wages
Bonuses / Incentives
Commissions
Investment Income:
Interest / Dividends
Rental Income
Loan Repayments
Business Income:
Self-Employment Draws
Partnership Draws
Royalties / License Fees
Retirement Income:
Social Security Income
Pension Benefits
Annuity Income
Retirement Account Withdrawals
Benefit/Insurance Related Income:
Unemployment Compensation
Disability Insurance Income
Long Term Care Insurance Income
Worker’s Compensation Income
Other Types of Income:
Reverse Mortgage Income
Alimony
Child Support
Court Settlement
Other
Other
TOTAL MONTHLY FAMILY INCOME = $_______________.
Monthly Expense Information: The expenses input here should be those that are actually paid each month. If you have expenses that are only paid a few times per year, add up the amounts and divide by twelve to get the average monthly amount.
Monthly Expenses:
Fixed Expenses:
Auto: Gas / Maintenance / Repairs
Alimony / Child Support
Commuting (other than Auto)
Child Care
Clothing
Education (other than Student Loans)
Groceries: Food / Household Supplies
Household Maintenance / Repairs
Insurance Premiums:
Auto
Disability
Home / Property
Life / Accident
Medical / Dental / Medicare
Other
Loan Payments:
Auto
Credit Cards / Charge Accounts
Home Equity
Student Loans
Other Loans
Medical / Dental Expenses not paid by insurance
Mortgage / Rent / HOA Dues
Personal Care (Hair / Cosmetics / etc.)
Pet Food / Care
Savings:
Taxable Savings / Investment Accounts
Retirement Plan Contributions (IRA / 401k / 403b / etc.)
Taxes:
Income / Federal / State / Local / Other
Property Tax – Real Estate / Personal
Telephone
Utilities:
Cable / Satellite TV
Electricity
Heating / Gas / Oil / Other
Water
Garbage Collection
Total Monthly Fixed Expenses:
Variable (Discretionary) Expenses:
Club Memberships
Dining (Restaurants)
Donations
Elective Medical Procedures
Entertainment (movies, plays, books, music, etc)
Gifts
Hobbies
Purchases: Cars and other big ticket items
Recreation
Subscriptions: Magazines / Newspapers / Books
Vacations
Other Items
Total Monthly Variable (Discretionary) Expenses
TOTAL MONTHLY EXPENSES - $_____________________.
TOTAL MONTHLY FAMILY INCOME $_______________
SUBTRACT TOTAL MONTHLY EXPENSES $_______________
NET MONTHLY CASH FLOW $_______________
Prepare your Budget:
With the information from above, you are now ready to prepare your budget. You can find find printable budget forms and budgeting software on the PF SAGE website here www.personalfinancesage.com. If you would prefer, email us and we will send you free Excel forms to use.
Analysis of your Budget:
With your personal information organized and your budget categories filled in, you have completed the easy part. The hard part is analyzing what you spend and how much you save. By completing the budget format above, you have already separated your expenses between needs (fixed expenses) and wants (variable or discretionary expenses). Keep in mind some fixed expenses such as automotive, clothing, personal care are “needs” up to a point and then they become luxury items. For instance if you own an expensive imported car, or designer clothes, you will need to be aware of the additional cost of owning these items over more basic brands.
You have money left over: Hopefully, after completing this exercise you will find your self with surplus money that you can begin to use for additional savings or for other goals. Make sure your expenses include any and all expense items to come in the coming months such as taxes or insurance premiums as you do not want to have a surplus in one month only to be short the next. If you have completed a month-to-month budget for the next year you should have accounted for these expenses.
You have a shortfall: If your net monthly cash flow is negative, there are only two things you can do: spend less or earn more. It may be helpful to compare your income to only your fixed expenses to help determine the effect of your cash flow picture from variable or discretionary expenses. In many cases, your discretionary expenses can be greatly reduced, giving you extra cash for debt repayment or savings. Depending on how much the monthly shortfall is you may only need to reduce some of your luxuries such as dining out less often or postponing a vacation. In other cases you may need to take a hard look at your fixed expenses, sell off assets you own, or move into a more affordable residence. Remember, a high priority should be placed on building emergency cash reserves if you don’t already have this available. Here are some things you may want to consider in balancing your budget:
Decrease Variable/Discretionary Expenses:
It should go without saying that if you are short each month on your budget, the first place you should look to cut is within the portion of your expenses that are discretionary. These expenses include excessive automotive costs, excessive designer clothing expenses, club memberships, restaurant dining, entertainment, recreation, hobbies, big-ticket purchase, unnecessary home modifications, vacations. The severity of the shortfall will determine the level of cuts you have to make to these types of expenses. After you have taken measures to reduce and eliminate certain discretionary expenses you should take a close look at what you may be able to do to reduce your fixed expenses.
Decrease Fixed Expenses:
While it is essential that you continue to pay and not delay the payment of your basic necessary fixed expenses, there may be ways to decrease these amounts.
Mortgage - Look around for a home mortgage with more favorable terms and lower monthly payments. BEWARE: make sure you are fully aware of the types of mortgage loans you are looking at. Variable rate, balloon, interest only, and negative amortization loans, to name a few, can be dangerous to your financial health. While they might make sense for your particular situation, be sure you know of all of the risks associated with such mortgage products before signing on the dotted line.
Rental - If you rent the space where you live, shop around for a cheaper place. In this day and age, you may want to consider asking your landlord for a rate break. You might be surprised at the positive response in order to keep you as a tenant.
Food – Limit your food purchases to the necessities. Avoid gourmet food stores and buy in bulk when possible. Buy sale items and use coupons when available. You will be surprised at how much of a difference this can make in your monthly grocery bill.
Automotive - First of all look at the car you drive. Should you really afford it? Can you live with one less exepnsive to help you accomplish other, more important, goals? If you are upside down on the value of the car versus the loan balance, don't perpetuate it by buying another car you can't afford. Have a plan and get out cycle as quickly as possible. Keep your vehicles maintenance history up to date. Make sure your tires are always at the recommended limit. Low tire pressure, other than the excessive wear and tear, can decrease your average gas mileage. Look into other transit options such as the subway, bus, and carpool. Check to see if your employer offers reimbursement for these other transit options.
Clothing – Purchase clothes that you actually need and not more. Clothing is one of those items that can easily blow any budget. Be aware of how much you need and how much you spend on what you need. Shop for sales and clearance items when possible. Buy your clothing needs at times where they are considered off-season. You can almost always find these items on sale at these times. Even better, buy clothes at donation centers such as Goodwill or Amvets. You would be surprised at the quality clothes you can get for next to nothing.
Telephone – If you have a home telephone and a mobile phone, consider eliminating one of them. If you need to keep the mobile phone, do you need to also have a home phone? Many people are finding that the redundancy of having a mobile phone and a home phone is unnecessary. Keep in mind, that if you eliminate your home phone, you are dependent on the mobile service quality in your area. You may also want to consider the various rates from the competing providers. You may be able to lower your monthly cost by switching providers.
Utilities – Proper home maintenance on your central air system such as clean air filters, vents, weather striping around doors and windows can make a big difference in your monthly electricity bill. Have your local utility company inspect your house if the free service is provided (many will offer this free service once per year). When was the last time you looked at your television cable or sattelite bill? If you are like most people these days you have "bundled" package that includes your television reception, internet service, and telephone. Bundled packages usually mean that they charge you a bundle. Look at the details and pressure your provider to lower the cost. Do away with unnecessary additions to your service such as multiple reception boxes and channels that you don't use.
Insurance – Be sure you have the appropriate insurance coverage for your personal situation. This is extremely important. Speak to your insurance professional. One great source for insurance information is AAA (the Auto Club). Once you have determined the appropriate coverage, then should shop around for the most competitive rates. KEY POINT - Shop around! With the interent this is a no brainer.
Increase Income:
I save an evaluation of income for last since I think many people will think of these things first before coming to the realization that what they really need to do is spend less. Nevertheless, here are a couple of ideas.
- Sale of property such as stocks, bonds, personal property items and other items to raise cash. You may be able to use this money to reduce high interest credit card debt, or provide some time to reestablish a more affordable lifestyle.
- Take on a job that pays more.
- Earn more by taking on a second job or have others in your family work.
Tracking Your Expenses:
Preparing your budget is a great start to managing your personal finances but it is just the beginning. In order for your plan to be successful, you need to track your expenses and then compare them with your budgeted expectations. Only then can you evaluate where reality separated from your expectations.
One of the best solutions for tracking expenses is by using financial software such as Quicken. Quicken can be set up to automatically download all banking, credit card, and investment transactions from hundreds of different financial institutions. Programs such as this one offer a wealth of planning information and resources. You can find links to various software programs at www.personalfinancesage.com.
If you are less interested in automating your personal financial management on a computer you could use a budget template and input your expenses manually throughout the month. Either way, be sure to be diligent in updating your information regularly otherwise it will be difficult to keep track of how well you are keeping to your budget.
Good luck with it!
There is no right or wrong way to budget your money so long as you remember that managing your finances is not a one-time activity but a lifelong commitment. The best budget is one that allows you to stay interested in keeping up with it. A simple budget process is described for you to use below.
What is a budget?
A budget is a written allocation of the financial resources you have available to you. Many people use software programs such as Quicken that can integrate the budgeting process with managing bank and credit card accounts. Other people track budgets on spreadsheets. It can be measured on any time frame basis such as daily, weekly, monthly, annually, and so on. Usually household budgets are prepared and tracked on a weekly or monthly basis. Some people even manage in accordance with daily expense allotments. However you choose to manage your budget manage it regularly. For the purposes of our illustration, we will use a monthly budget. An income and expense data worksheet is provided below.
Monthly Income Information: For the purposes of gathering data, it is recommended that you use a monthly format. You can prepare a budget from this information on a weekly or monthly basis depending on the level of discipline you want. Input the monthly information for each item in the list below. If necessary, use estimates in order to get the monthly amount.
Monthly Income:
Employer Income:
Salary / Wages
Bonuses / Incentives
Commissions
Investment Income:
Interest / Dividends
Rental Income
Loan Repayments
Business Income:
Self-Employment Draws
Partnership Draws
Royalties / License Fees
Retirement Income:
Social Security Income
Pension Benefits
Annuity Income
Retirement Account Withdrawals
Benefit/Insurance Related Income:
Unemployment Compensation
Disability Insurance Income
Long Term Care Insurance Income
Worker’s Compensation Income
Other Types of Income:
Reverse Mortgage Income
Alimony
Child Support
Court Settlement
Other
Other
TOTAL MONTHLY FAMILY INCOME = $_______________.
Monthly Expense Information: The expenses input here should be those that are actually paid each month. If you have expenses that are only paid a few times per year, add up the amounts and divide by twelve to get the average monthly amount.
Monthly Expenses:
Fixed Expenses:
Auto: Gas / Maintenance / Repairs
Alimony / Child Support
Commuting (other than Auto)
Child Care
Clothing
Education (other than Student Loans)
Groceries: Food / Household Supplies
Household Maintenance / Repairs
Insurance Premiums:
Auto
Disability
Home / Property
Life / Accident
Medical / Dental / Medicare
Other
Loan Payments:
Auto
Credit Cards / Charge Accounts
Home Equity
Student Loans
Other Loans
Medical / Dental Expenses not paid by insurance
Mortgage / Rent / HOA Dues
Personal Care (Hair / Cosmetics / etc.)
Pet Food / Care
Savings:
Taxable Savings / Investment Accounts
Retirement Plan Contributions (IRA / 401k / 403b / etc.)
Taxes:
Income / Federal / State / Local / Other
Property Tax – Real Estate / Personal
Telephone
Utilities:
Cable / Satellite TV
Electricity
Heating / Gas / Oil / Other
Water
Garbage Collection
Total Monthly Fixed Expenses:
Variable (Discretionary) Expenses:
Club Memberships
Dining (Restaurants)
Donations
Elective Medical Procedures
Entertainment (movies, plays, books, music, etc)
Gifts
Hobbies
Purchases: Cars and other big ticket items
Recreation
Subscriptions: Magazines / Newspapers / Books
Vacations
Other Items
Total Monthly Variable (Discretionary) Expenses
TOTAL MONTHLY EXPENSES - $_____________________.
TOTAL MONTHLY FAMILY INCOME $_______________
SUBTRACT TOTAL MONTHLY EXPENSES $_______________
NET MONTHLY CASH FLOW $_______________
Prepare your Budget:
With the information from above, you are now ready to prepare your budget. You can find find printable budget forms and budgeting software on the PF SAGE website here www.personalfinancesage.com. If you would prefer, email us and we will send you free Excel forms to use.
Analysis of your Budget:
With your personal information organized and your budget categories filled in, you have completed the easy part. The hard part is analyzing what you spend and how much you save. By completing the budget format above, you have already separated your expenses between needs (fixed expenses) and wants (variable or discretionary expenses). Keep in mind some fixed expenses such as automotive, clothing, personal care are “needs” up to a point and then they become luxury items. For instance if you own an expensive imported car, or designer clothes, you will need to be aware of the additional cost of owning these items over more basic brands.
You have money left over: Hopefully, after completing this exercise you will find your self with surplus money that you can begin to use for additional savings or for other goals. Make sure your expenses include any and all expense items to come in the coming months such as taxes or insurance premiums as you do not want to have a surplus in one month only to be short the next. If you have completed a month-to-month budget for the next year you should have accounted for these expenses.
You have a shortfall: If your net monthly cash flow is negative, there are only two things you can do: spend less or earn more. It may be helpful to compare your income to only your fixed expenses to help determine the effect of your cash flow picture from variable or discretionary expenses. In many cases, your discretionary expenses can be greatly reduced, giving you extra cash for debt repayment or savings. Depending on how much the monthly shortfall is you may only need to reduce some of your luxuries such as dining out less often or postponing a vacation. In other cases you may need to take a hard look at your fixed expenses, sell off assets you own, or move into a more affordable residence. Remember, a high priority should be placed on building emergency cash reserves if you don’t already have this available. Here are some things you may want to consider in balancing your budget:
Decrease Variable/Discretionary Expenses:
It should go without saying that if you are short each month on your budget, the first place you should look to cut is within the portion of your expenses that are discretionary. These expenses include excessive automotive costs, excessive designer clothing expenses, club memberships, restaurant dining, entertainment, recreation, hobbies, big-ticket purchase, unnecessary home modifications, vacations. The severity of the shortfall will determine the level of cuts you have to make to these types of expenses. After you have taken measures to reduce and eliminate certain discretionary expenses you should take a close look at what you may be able to do to reduce your fixed expenses.
Decrease Fixed Expenses:
While it is essential that you continue to pay and not delay the payment of your basic necessary fixed expenses, there may be ways to decrease these amounts.
Mortgage - Look around for a home mortgage with more favorable terms and lower monthly payments. BEWARE: make sure you are fully aware of the types of mortgage loans you are looking at. Variable rate, balloon, interest only, and negative amortization loans, to name a few, can be dangerous to your financial health. While they might make sense for your particular situation, be sure you know of all of the risks associated with such mortgage products before signing on the dotted line.
Rental - If you rent the space where you live, shop around for a cheaper place. In this day and age, you may want to consider asking your landlord for a rate break. You might be surprised at the positive response in order to keep you as a tenant.
Food – Limit your food purchases to the necessities. Avoid gourmet food stores and buy in bulk when possible. Buy sale items and use coupons when available. You will be surprised at how much of a difference this can make in your monthly grocery bill.
Automotive - First of all look at the car you drive. Should you really afford it? Can you live with one less exepnsive to help you accomplish other, more important, goals? If you are upside down on the value of the car versus the loan balance, don't perpetuate it by buying another car you can't afford. Have a plan and get out cycle as quickly as possible. Keep your vehicles maintenance history up to date. Make sure your tires are always at the recommended limit. Low tire pressure, other than the excessive wear and tear, can decrease your average gas mileage. Look into other transit options such as the subway, bus, and carpool. Check to see if your employer offers reimbursement for these other transit options.
Clothing – Purchase clothes that you actually need and not more. Clothing is one of those items that can easily blow any budget. Be aware of how much you need and how much you spend on what you need. Shop for sales and clearance items when possible. Buy your clothing needs at times where they are considered off-season. You can almost always find these items on sale at these times. Even better, buy clothes at donation centers such as Goodwill or Amvets. You would be surprised at the quality clothes you can get for next to nothing.
Telephone – If you have a home telephone and a mobile phone, consider eliminating one of them. If you need to keep the mobile phone, do you need to also have a home phone? Many people are finding that the redundancy of having a mobile phone and a home phone is unnecessary. Keep in mind, that if you eliminate your home phone, you are dependent on the mobile service quality in your area. You may also want to consider the various rates from the competing providers. You may be able to lower your monthly cost by switching providers.
Utilities – Proper home maintenance on your central air system such as clean air filters, vents, weather striping around doors and windows can make a big difference in your monthly electricity bill. Have your local utility company inspect your house if the free service is provided (many will offer this free service once per year). When was the last time you looked at your television cable or sattelite bill? If you are like most people these days you have "bundled" package that includes your television reception, internet service, and telephone. Bundled packages usually mean that they charge you a bundle. Look at the details and pressure your provider to lower the cost. Do away with unnecessary additions to your service such as multiple reception boxes and channels that you don't use.
Insurance – Be sure you have the appropriate insurance coverage for your personal situation. This is extremely important. Speak to your insurance professional. One great source for insurance information is AAA (the Auto Club). Once you have determined the appropriate coverage, then should shop around for the most competitive rates. KEY POINT - Shop around! With the interent this is a no brainer.
Increase Income:
I save an evaluation of income for last since I think many people will think of these things first before coming to the realization that what they really need to do is spend less. Nevertheless, here are a couple of ideas.
- Sale of property such as stocks, bonds, personal property items and other items to raise cash. You may be able to use this money to reduce high interest credit card debt, or provide some time to reestablish a more affordable lifestyle.
- Take on a job that pays more.
- Earn more by taking on a second job or have others in your family work.
Tracking Your Expenses:
Preparing your budget is a great start to managing your personal finances but it is just the beginning. In order for your plan to be successful, you need to track your expenses and then compare them with your budgeted expectations. Only then can you evaluate where reality separated from your expectations.
One of the best solutions for tracking expenses is by using financial software such as Quicken. Quicken can be set up to automatically download all banking, credit card, and investment transactions from hundreds of different financial institutions. Programs such as this one offer a wealth of planning information and resources. You can find links to various software programs at www.personalfinancesage.com.
If you are less interested in automating your personal financial management on a computer you could use a budget template and input your expenses manually throughout the month. Either way, be sure to be diligent in updating your information regularly otherwise it will be difficult to keep track of how well you are keeping to your budget.
Good luck with it!
The Basics: What is Personal Finance?
Broadly defined, personal finance is the application of finance principles to the decisions you make about your money. This includes choices you make about earning, saving, spending, investing, insuring, and planning for the way you will manage these things now and in the future. Many people are afraid of these things, and that's ok so long as you are not paralized by it. Channel that fear into knowledge of your situation and action. Doing so will leave you with a feeling of relief that you might have never thought possible.
Many people narrowly interpret the term “financial plan” to mean investment plan. While an investment plan is an important component, it isn’t all that is necessary for a complete financial plan. One reason for such narrow focus is that it’s what most people talk about. After all, stock market news channels broadcast around the clock to popularize the act of investing, magazines breakdown the success and failure of virtually every investment available, internet sites promise ways to get rich by purchasing their investment advice. What’s more, if you know a little something about the stock market, doesn’t it make you more “in the game” and more likely to succeed financially in the future? The up to the minute knowledge of the direction of the stock market and the act of owning a few investments here and there will in fact not make you a personal finance champion. What will give you personal financial freedom is understanding your situation, planning a way to achieve the goals that you set for yourself, and following through with your plan. The simple act of preparing a financial plan will give you a sense of power in taking control of your finances.
Personal Financial Planning
A personal financial plan can include several components:
What do you want to accomplish? – You must begin this process by thinking about, and writing down, what your specific financial goals are: I want to get out of debt – I want to retire comfortably – I want to save for a house… These are important things and there are tools here to help you answer these questions. I would encourage you not to limit your plan with specific topics such as these but to expand your plan for the entire scope of your financial life. This includes a strategy for budgeting, investing and building wealth, insurance planning, estate planning, and setting up a method for periodically modifying and updating your plan.
Understand your situation – In order to achieve your financial goals you must first understand your current situation. You can plan and set goals only after you have developed your start point. Don’t hide from your finances just because you are afraid of what you might find. It really doesn’t matter how good or how bad your situation is, the truth is it won’t change by ignoring it. For many people this is the toughest obstacle to overcome.
Take action, collect information - Once you have allowed yourself to explore your situation, collect all of your financial information in one place. To begin the process, if you do nothing but pull the information all together, the act of doing this is a huge step in the process of planning for your financial future.
Write everything down – Compile all the information in one place. Getting organized is a key beginning to this process.
Communication – If you share your financial life with a partner, communication with that person is crucial to the success of your plan. This is often a source of frustration for many people and opening a dialogue with your partner is critical. Sometimes the best way to do this is in small increments over a period of time. Pick a topic to discuss, such as compiling the records, and talk for a short period of time. This way you gradually align your interests so that you are tackling the same problems together. If only one of you tackles the effort, the other will have a more difficult time taking ownership of the process. TAKING OWNERSHIP OF THE PROCESS IS KEY. Dividing responsibilities can be good, but be careful to work as a team on all aspects of the process.
Budgeting - There is one very important thing to remember when uncovering the mysteries of budgeting – it’s just math. A budget is quite simply adding up what you bring in each month and subtracting what you pay out each month. It’s not difficult to generate and managing it it’s the most important thing you will do to achieve your long-term financial goals. It doesn’t matter how much money you make, the math within a budget will always work the same. If you spend more than you make on a consistent basis, this will not be good for you. Over time you will find yourself borrowing money in order to pay for your excess spending.
Saving and Investing – Developing a saving plan is a very important part of your budget. Once you have determined a way to save on a regular basis, you should decide how to put that savings to work. Your investment plan should first include an understanding of investment concepts so you can use them within your plan. These concepts include various investment product choices, retirement accounts, taxable accounts, education accounts, real estate, and others.
Taxes – Having a tax plan is something to think about after you have a firm grasp of your over all personal financial profile.
Insurance – Insurance products are a very important part of anyone’s personal financial picture. Whether it be life, health, disability, long-term care, homeowner, or automotive insurance, a basic understanding of how they work is critical to determining what type and how much you should have.
Estate Planning – Basic estate planning, such as a Will and Power of Attorney for Healthcare Decisions, should be added to your to-do list. You don't need to spend a great deal of money to put these documents in place. There are great do-it-yourself sites that can help you for minimal cost.
Debt Reduction – Before you dive into the debt reduction process you should educate yourself to the different types of debt and where they are and aren't appropriate. There is debt that can be used for investing in the future (such as education or a business), debt that can be used for investing in appreciable assets (real estate), and debt that can be used for consumer spending. Although all debt can be dangerous if not structured and used properly, consumer debt can be particularly harmful to your financial health. Many people have too much debt. Reasons can vary from the loss of a job, unexpected expense, divorce, medical condition, loss of family member, or simply living a life of unhealthy and excessive spending habits. If you have too much debt, you may fall into one of these categories. The good news is that for most people, there is a solution. It will require understanding of your situation, development of a plan, and action. And the action may not be easy. As you go through the process, the act of doing something about your situation will hopefully provide you with some relief from anxiety.
Internet resources – A wealth of resources are available on the Internet for personal finance management. We have provided helpful links to many of the most helpful sites for various topics. Information on the various types of software available is provided along with some basic advice on how to manage the software on a regular basis. Using financial software is a great way to maintain your budget and financial plan.
Other sources – Do-it-yourself sites can provide tremendous amounts of helpful information. In fact there is enough information here to create an entire financial plan as long as you have the discipline to carry it through. Many times though, people need a more hand’s on approach to this type of planning or just want a professional looking over the shoulder. If this is the case for you we have devoted a section designed to help you understand the various types of financial planners and advisors as well as determining which one is right for you.
Whether or not you create the plan yourself or use the help of a professional, the plan by itself is not something to develop and put on a shelf. The planning process should be engaging and interactive in order for you to learn from the experience. The end financial plan is of course an important tool for you to use throughout your life, but the process will allow you the time and resources to digest many important financial concepts. In addition, taking action as part of the process will help alleviate many stresses you may have by taking control.
Procrastinating will never help you achieve your ultimate goal.
Many people narrowly interpret the term “financial plan” to mean investment plan. While an investment plan is an important component, it isn’t all that is necessary for a complete financial plan. One reason for such narrow focus is that it’s what most people talk about. After all, stock market news channels broadcast around the clock to popularize the act of investing, magazines breakdown the success and failure of virtually every investment available, internet sites promise ways to get rich by purchasing their investment advice. What’s more, if you know a little something about the stock market, doesn’t it make you more “in the game” and more likely to succeed financially in the future? The up to the minute knowledge of the direction of the stock market and the act of owning a few investments here and there will in fact not make you a personal finance champion. What will give you personal financial freedom is understanding your situation, planning a way to achieve the goals that you set for yourself, and following through with your plan. The simple act of preparing a financial plan will give you a sense of power in taking control of your finances.
Personal Financial Planning
A personal financial plan can include several components:
What do you want to accomplish? – You must begin this process by thinking about, and writing down, what your specific financial goals are: I want to get out of debt – I want to retire comfortably – I want to save for a house… These are important things and there are tools here to help you answer these questions. I would encourage you not to limit your plan with specific topics such as these but to expand your plan for the entire scope of your financial life. This includes a strategy for budgeting, investing and building wealth, insurance planning, estate planning, and setting up a method for periodically modifying and updating your plan.
Understand your situation – In order to achieve your financial goals you must first understand your current situation. You can plan and set goals only after you have developed your start point. Don’t hide from your finances just because you are afraid of what you might find. It really doesn’t matter how good or how bad your situation is, the truth is it won’t change by ignoring it. For many people this is the toughest obstacle to overcome.
Take action, collect information - Once you have allowed yourself to explore your situation, collect all of your financial information in one place. To begin the process, if you do nothing but pull the information all together, the act of doing this is a huge step in the process of planning for your financial future.
Write everything down – Compile all the information in one place. Getting organized is a key beginning to this process.
Communication – If you share your financial life with a partner, communication with that person is crucial to the success of your plan. This is often a source of frustration for many people and opening a dialogue with your partner is critical. Sometimes the best way to do this is in small increments over a period of time. Pick a topic to discuss, such as compiling the records, and talk for a short period of time. This way you gradually align your interests so that you are tackling the same problems together. If only one of you tackles the effort, the other will have a more difficult time taking ownership of the process. TAKING OWNERSHIP OF THE PROCESS IS KEY. Dividing responsibilities can be good, but be careful to work as a team on all aspects of the process.
Budgeting - There is one very important thing to remember when uncovering the mysteries of budgeting – it’s just math. A budget is quite simply adding up what you bring in each month and subtracting what you pay out each month. It’s not difficult to generate and managing it it’s the most important thing you will do to achieve your long-term financial goals. It doesn’t matter how much money you make, the math within a budget will always work the same. If you spend more than you make on a consistent basis, this will not be good for you. Over time you will find yourself borrowing money in order to pay for your excess spending.
Saving and Investing – Developing a saving plan is a very important part of your budget. Once you have determined a way to save on a regular basis, you should decide how to put that savings to work. Your investment plan should first include an understanding of investment concepts so you can use them within your plan. These concepts include various investment product choices, retirement accounts, taxable accounts, education accounts, real estate, and others.
Taxes – Having a tax plan is something to think about after you have a firm grasp of your over all personal financial profile.
Insurance – Insurance products are a very important part of anyone’s personal financial picture. Whether it be life, health, disability, long-term care, homeowner, or automotive insurance, a basic understanding of how they work is critical to determining what type and how much you should have.
Estate Planning – Basic estate planning, such as a Will and Power of Attorney for Healthcare Decisions, should be added to your to-do list. You don't need to spend a great deal of money to put these documents in place. There are great do-it-yourself sites that can help you for minimal cost.
Debt Reduction – Before you dive into the debt reduction process you should educate yourself to the different types of debt and where they are and aren't appropriate. There is debt that can be used for investing in the future (such as education or a business), debt that can be used for investing in appreciable assets (real estate), and debt that can be used for consumer spending. Although all debt can be dangerous if not structured and used properly, consumer debt can be particularly harmful to your financial health. Many people have too much debt. Reasons can vary from the loss of a job, unexpected expense, divorce, medical condition, loss of family member, or simply living a life of unhealthy and excessive spending habits. If you have too much debt, you may fall into one of these categories. The good news is that for most people, there is a solution. It will require understanding of your situation, development of a plan, and action. And the action may not be easy. As you go through the process, the act of doing something about your situation will hopefully provide you with some relief from anxiety.
Internet resources – A wealth of resources are available on the Internet for personal finance management. We have provided helpful links to many of the most helpful sites for various topics. Information on the various types of software available is provided along with some basic advice on how to manage the software on a regular basis. Using financial software is a great way to maintain your budget and financial plan.
Other sources – Do-it-yourself sites can provide tremendous amounts of helpful information. In fact there is enough information here to create an entire financial plan as long as you have the discipline to carry it through. Many times though, people need a more hand’s on approach to this type of planning or just want a professional looking over the shoulder. If this is the case for you we have devoted a section designed to help you understand the various types of financial planners and advisors as well as determining which one is right for you.
Whether or not you create the plan yourself or use the help of a professional, the plan by itself is not something to develop and put on a shelf. The planning process should be engaging and interactive in order for you to learn from the experience. The end financial plan is of course an important tool for you to use throughout your life, but the process will allow you the time and resources to digest many important financial concepts. In addition, taking action as part of the process will help alleviate many stresses you may have by taking control.
Procrastinating will never help you achieve your ultimate goal.
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