As we wind down 2007, certain financial trends seem to be accelerating: As a nation, we’re still spending more than we earn. Credit, which has been the backbone of our ability to live beyond our means, appears to be tightening. And, home values have fallen nationally (although they may be up in your particular neighborhood), eroding our home equity.
What does that mean for 2008? It may be harder to qualify for home equity loans and lines of credit to support all the consumer spending we’ve seen in recent years. And, if you carry a balance on your credit cards, you may pay a higher rate of interest even as the Federal Reserve lowers the federal funds rate.
If you’re already living beyond your means, and your adjustable-rate mortgage (ARM) is scheduled to rise this year, you could be running into a brick wall. Since the U.S. bankruptcy laws changed several years ago, it’s harder to get your financial slate wiped clean.
Both foreclosure and doing a “deed-in-lieu,” where you give the bank the deed to your house in exchange for walking away from your mortgage obligations, aren’t easy solutions either. Foreclosures are at a 21-year high, which means banks are less than happy at getting another set of house keys to hang on their office wall. There are a lot of vacant homes for sale, and while they are indeed selling, they’re not selling quickly.
So what’s the answer?
Managing your financial future means taking responsibility for your major assets, including your real estate, your stocks and bonds, and any retirement accounts you may have. It also means spending less and saving more. And, at the bottom line, it means living within your means.
So, let’s start off 2008 on the right foot financially. Even if you spent every dime you had and rang up your credit card or home equity debt, this is a new year. The best gift you can give your financial future is a fresh start.
That way, if there are rainy days ahead, you’ll have an umbrella and perhaps even a pair of funky rubber boots. Here’s my annual list of personal finance resolutions you may wish to consider implementing this year:
1. Put yourself on a budget. Let’s start with something simple: spending less than you earn. Buy in bulk (if it’s cheaper), at sales, and in advance of when you’ll actually need something. (If you wait until the last minute, it’ll be more expensive.) Cook at home more often, and use coupons if you can. Avoid take-out and eating out.
2. Pay off your charge cards. The average American has more than $9,000 in credit card debt. That’s in addition to a mortgage and a car loan. Debt isn’t much of a problem unless you have financial dreams you hope to achieve — or you like to sleep at night. For future homeowners, every dollar you spend to pay down your charge card debt or car loan each month is a dollar less that you’ll be able to put toward your monthly mortgage payment.
Finally, while you’re paying off your charge cards, remember to pay them on time. Paying on time, over time, is the sure-fire way to improve your credit history.
3. Pay yourself first and last. This little bit of common sense is particularly helpful if you’re trying to save for a down payment or another major purchase. Each month, make out an invoice to yourself for the amount you wish you were saving. It could be $50 or $500. When you pull out your checkbook to pay your bills each month, take out the invoice and literally pay it first. Then, if you have any cash left over in your checking account at the end of your bill-paying session, pay yourself again.
The high-tech way to do this, of course, is to have your bank or financial investment company electronically pull the money out of your checking account each month. Remember to mark this down, however, or you could wind up bouncing checks and needlessly spending additional dollars.
Once the money is out of your checkbook, you won’t spend it on something else. It doesn’t matter where you put the money, although if you write the check to your Roth IRA account, you’ll get a bonus: The money will grow tax-free forever. Looking for another good idea? Send the second check to your child’s 529 college savings plan. The money will also grow free of state and federal taxes (depending on the plan you choose), and you may get a state tax deduction for your contribution next April 15.
Last year, companies began introducing the Roth 401(k), an after-tax option that allows you to salt another $15,000 away for your retirement. Like a Roth IRA, the cash grows tax-free forever. While there are no income limits, your company has to offer it as a benefit. See your human resources department for details.
4. Pre-pay your home loan. Another way to save big over time is to contribute a few extra dollars each month to your mortgage. Because of the way compounding works, every dollar you pre-pay saves you hundreds or thousands of dollars in interest over the life of your loan.
If you make one extra payment per year (either in a lump sum on Jan. 1, or in 1/12 payments attached to your monthly payment), you’ll cut your 30-year loan to about 21 years. If you make two extra payments per year, you’ll cut your 30-year loan almost in half.
If you don’t want the hassle but still want the savings, get a 15-year loan instead of a 30-year loan. Imagine buying your first home and paying it off by the time your toddler is ready for college.
5. Refinance when interest rates drop or when your credit improves. Refinancing your loan can be a good way to find extra money in your budget each month. If you can save even $50 per month, that’s $50 you can invest in yourself and your future.
Refinancing with a no-cost loan may be a good way to go, particularly if you’ll be staying only a few years in your home before selling. Otherwise, consider paying some costs or fees and taking a long-term view with a super-low interest rate.
This year should offer some excellent opportunities to refinance adjustable-rate mortgages (ARMs) that may be coming due. You may be able to refinance to another 5/1 ARM or even a 30-year fixed-rate loan and save money. With all of the subprime issues and mortgage problems out there, make sure you understand the fees involved in obtaining the loan, the rate you are getting for your loan now and in the future, and whether there are prepayment penalties associated with your loan.
6. Keep up with your home maintenance. If you keep your home in good shape, you’ll spend less over the years than if you let little things build into big problems that need replacing instead of repairing.
Regularly walk through your home, including the basement and attic, and around the exterior, looking for signs of rot, moisture or pest infestation. The sooner you take care of these problems, the easier and cheaper they will be.
7. Borrow down-payment money from your 401(k) or IRA only as a last resort. The government allows you to withdraw up to $10,000 from an IRA account for the purchase of a first home (you’ll pay taxes owed but no penalties on the withdrawal). Whether or not you can borrow any amount from your 401(k) or other retirement plan at work depends on the plan rules (check with your plan administrator).
Either way, carefully think it through before you take the cash from these accounts. If the $10,000 is your entire retirement kitty, you may be jeopardizing a secure retirement. If the $10,000 represents only a fraction of your retirement savings, you may have more flexibility.
The better solution is to simply borrow the money from another source. If you take out a larger mortgage, you may pay private mortgage insurance (PMI). The good news is that for new loans taken out as of Jan. 1, 2007, your PMI premium is tax-deductible (if you earn $100,000 per year or less) and, your tax-deferred cash will continue to grow intact.
8. Contribute the maximum to your retirement plan. If your employer offers you a retirement plan, sign up as quickly as possible to take full advantage of it. If your employer doesn’t offer a retirement plan, open up a Roth IRA as quickly as possible.
Retirement plans offer you tax-deductible and tax-deferred growth. That means, your money is growing far faster than if you had to use after-tax dollars or if you had to pay taxes on your earnings each year. If your employer matches your contributions, every dollar of that match is free money.
9. Save your change. Every day when you get home, empty your pockets (or wallet) of change into a glass jar. After two weeks, drop the change and your lowest denomination bill into the jar. At the end of a month or two, take it to the bank. You’ll be shocked by how much you’ll save and how you’ll never miss it.
Creating a solid financial future isn’t about winning the lottery or speculating on a hot stock tip. It’s about being smart with the dollars you have in your checking account at the end of the month and the change left in your pocket at the end of the day.
Don’t expect your savings to grow overnight, but if you start to implement a few of these strategies, by this time next year, you’ll notice a significant improvement in your financial well-being.
