Financial literacy is a passion of mine, and I have been given the opportunity to share my passion through a series of posts on financial literacy. Apparently I also have a passion for list-making, so this works out! You can catch my earlier post, “Ask a Mom: A Banker’s Tips to Help You Reach Your Financial Goals–Part One,” by clicking here.
Some fine print: I am not an attorney, you should always consult a CPA for tax advice, and the opinions I express here are my own and not that of my employer. Still with me? Awesome.
Let’s talk about debt and savings strategies. Here are my tips:
Know your numbers. Knowing where your money goes is important, but what you do with the information is equally important. In my last post I talked about budgeting. Hopefully you found that your family is doing OK, even if you spend twice your monthly HEB bill on fast food and restaurants. At least you’re all fed, right? If you found some issues, addressing them is important. Otherwise you were just writing everything down for fun, and now in addition to having an issue you also look a little crazy with all those receipts in an envelope. I’m kidding, but most problems don’t go away on their own. I’m turning into my mother by saying that. Yikes!
Obviously, life is best when your income is higher than your expenses. However, there are other general guidelines that will help you better understand where you are, financially. One interesting piece of information is your housing burden. Take your monthly gross income (income before taxes) and multiply it by 0.30. Is that number lower than your monthly rent or mortgage payment? If it is, the Department of Housing and Urban Development (HUD) classifies your family as cost-burdened. Families with a high housing cost-burden, those who pay more than 30% of their income on housing, may have difficulty affording necessities such as food, clothing, transportation, and medical care.
A high housing cost-burden can also impact your ability to access credit. Lenders will calculate your debt-to-income ratio (DTI) when you apply for a loan or credit card. Financial institutions have individual policies, but generally a range between 35%–43% is considered acceptable. To calculate your DTI, add together your monthly: rent or mortgage payment, alimony and child support payments, regular loan payments (auto, student loan), and the minimum payment of all your credit cards. Have a number? Now divide that number by your monthly income before taxes. The result is your debt-to-income ratio. Write it down; I’ll come back to DTI later.
Save for an emergency first. When I think about saving, there are a few things I know I need: an emergency fund, retirement savings, and a college fund for my daughter. But am I saving enough? What is enough? This part of finance is tricky, because every family and situation are unique. Looking at your monthly budget, hopefully you are saving a portion of your income. Generally, saving between 10%–20% of your income is ideal. Do not despair if you are not there. The Average American Savings Rate reported by the government periodically recently ranged between 3%–5%.
If you need a more concrete target, start with $500. A Bankrate poll conducted in early 2017 found that six in 10 Americans could not cover an unexpected $500 emergency expense. Of those that said they could, many would use credit cards. Saving now will give your family more options later. If $500 sounds low, think of the largest unexpected expense that occurred for your family in the last year and make that your goal.
Are you an overachiever at heart? Plan to save three to six months’ worth of monthly income. Recommended by planners prior to the Great Recession, and many after, this target will provide your family with an income cushion if you lose your job. Why three to six months? At the time it was said to be the average amount of time an individual spent looking for a similar job. I have heard some advisors suggest eight to 12 months now, but I’m trying to keep this piece nonfiction, and setting that as a goal for myself would be like saying I’m going to lose 40 pounds. It’s not happening.
For a look at how time, monthly deposits, and interest impact your savings goals, check out this Simple Savings Tool.
Get comfortable with your debt. The topic of debt can be difficult to discuss. Depending on your experience, debt can be seen as a good thing or a bad thing. Having some debt demonstrates to creditors that you can manage debt wisely and make timely payments. However, having too much debt, or debt of the “wrong” type, can negatively affect your financial well-being and access to credit when you need it. I will talk about credit next time, but your debt-to-income ratio (DTI) is a good indicator of how seriously you need to look at your debts.
Debt reduction is a popular topic because almost all of us have debt. It is such a popular topic that there are many, many debt reduction strategies and philosophies that can be found online. The number one thing to remember when making a debt reduction plan: if it sounds too good to be true, it is. Yes, there are a handful of reputable, nonprofit organizations that will assist you with your debt reduction efforts. However, you will do much of the “heavy lifting” by making phone calls and gathering paperwork. No organization can do all the work for you. An ad that promises to settle your debt for pennies on the dollar likely does not work, or we would hear about it on the morning news and we would all be debt free.
Ready to make a plan? Generally, there are three options to choose from: high-low, low-high, and consolidation. If you have multiple monthly debt payments that you find annoying, and you have decent credit, a debt consolidation loan may be the solution. For many, debt consolidation is not an option due to credit concerns or because it will not save them money overall.
The high-low approach focuses on paying highest interest debts first, by paying only the minimum on other debts and paying more than minimum on the priority debt. This option will save you the most money over time, because you will be paying less in interest overall.
If you’re impatient like I am, however, the low-high method may be a better option. A low-high payment plan prioritizes the smallest balances first. This option produces progress quickly by paying off smaller balances, reducing the number of monthly bills. Known as the “snowball” approach, once a bill is paid the budgeted payment then gets added to the next priority payment’s minimum.
Student loan debt is a common reason individuals seek debt consolidation. Investigate your repayment options and how refinancing this type of debt can impact your options in the future using the CFPB Student Loan Resource Page.
Stay tuned! In my final post of the series I will be talking about credit and end-of-the-year checkups.