Ten Commandments of Saving Money

Ten Commandments of Saving Money

“Do not save what is left after spending, but spend what is left after saving.”

Warren Buffett

Warren Buffett’s quotes are timeless, reflecting his wisdom. His words on saving and investments are inspiring. Saving money is the cornerstone of a sound financial plan. Through discipline and hard work, we can save money to reward ourselves with financial flexibility. By making saving a priority and making your money work for you, you are more likely to achieve financial success.

Key Reasons To Save Money

  • Help to achieve our financial goals.
  • Pay our bills on time and entirely, so we don’t need to carry costly debt.
  • Provide an emergency cushion for unpredictable costs.
  • Set aside funds for our children’s college tuition and our retirement.
  • Make investments, the best way to build wealth.

I like to revisit ancient views of saving money from timeworn texts and stories. There is a common thread across varying beliefs on saving, avoid overspending, and investing for a better financial future. Surveying these words adds a different perspective on finances. In the companion Ten Commandments of Personal Finance, we look at home ownership, investing,  retirement, and debt management.

Ten Commandments of Saving Money:

 

1. Spend Within Your Means

Saving money is an essential financial habit. According to a CareerBuilder report, 78% of American workers are living paycheck-to-paycheck.  Even those with higher incomes of at least $100,000 (nearly 10%)  are having trouble making ends meet.

I grew up in a modest household that saved diligently. As a young girl, I didn’t always understand why we were having financial problems. My mom reminded us often that our needs exceeded our wants, and we had to be careful about spending. Later on, I learned that my parents set up a small retail business that took a long time to get off the ground. Savings became part of our mindset from then on.

Control thy expenditures.”

To set aside money for saving and investing, you may need to cut some costs. To control your expenses, assess what your necessary living needs are. These are predictable monthly fixed costs such as mortgage payments or rent, property taxes, utilities, car loans, typical grocery bills, credit card payments, and any expenses you pay monthly. Remember, these costs are for our needs rather than for our wants and desires.

Be reasonable about satisfying your every want. A rise in earnings may not fully accommodate every gratification we seek. For example, that 10% raise on your $80,000 salary may not significantly help you to buy that luxury car (or chariot in ancient times), you have been eyeing.

 

2. Build A Healthy Emergency Fund

As a result of the coronavirus pandemic, record jobless claims caused a dramatic slowdown of the economy. Although federal stimulus packages have added to state unemployment benefits, there is no guarantee this government aid will be ongoing. 

 Economic downturns are cyclical events you can’t time. They cause substantial financial stresses. Recessions remind us of the need for savings on hand. Having an emergency fund is necessary to pay for basic living expenses for at least six months, if not a year. Having readily accessible funds in liquid funds such as money market securities helps you avoid borrowing money.

Joseph’s Emergency Funds

Emergency funds as a prudent strategy appear in Genesis 41:34-36. In this passage, Joseph interprets Pharaoh’s dream about seven fat cows grazing by a river swallowed up by seven skinny cows. Joseph views the seven fat cows as seven prosperous years for Egypt, followed by seven years of famine. As a result of planning for this disaster, Joseph advises Pharaoh to store grain during the good years to use for more challenging years. Save when you have more for those times you have less due to job loss, illness, or crisis.

Adopting a habit of saving more provides you with more flexibility to allocate into investment and retirement savings. Begin by setting aside small amounts of savings of $1,000 but don’t stop there. Tough times prove that amount is inadequate. Don’t think of these savings as wasteful assets. Instead, it is a means to avoid higher debt levels. As Proverbs 13:11 tells us, “Dishonest money dwindles away, but whoever gathers money little by little makes it grow.”

Having Liquidity is Key

Liquidity refers to your ability to quickly convert assets into cash with little to no loss of principal. When your resources are liquid, you have the financial ability to pay for unexpected costs such as a loss of job, death in the family, or your roof is leaking. Monitor your liquidity levels periodically. 

Monetary assets are among the most liquid of holdings. These assets include cash, cash-equivalent securities or money markets, treasury bills, savings bonds, savings, and checking accounts. True, you won’t earn much income as interest rates are still low, but you avoid having to use your credit cards with borrowing rates in the mid-teens.  Use liquid assets to support your fixed monthly expenses for six months or more. Here are two benchmarks to use:

Liquidity Ratio= Monetary Assets/ Monthly Expenses

Your monetary assets should support your fixed monthly expenses such as groceries, rent or mortgage, utilities, and a car loan for six months. A ratio of 6 means having six months of monetary assets to pay for your basic needs of food, rent, utilities, and car loan, if necessary.

 Emergency Fund Ratio

The liquidity ratio is linked very closely to emergency funds. This ratio is essentially a cash fund for emergencies in unforeseen events such as job loss, death in the family, unexpected surgery, or immediate house repair. It works by using a targeted number of months that you believe is ample to support you through emergencies. If you are looking for six months or higher (and this is highly recommended) to set aside money in a high yield savings account or money markets account, then:

Emergency Funds Ratio= 6*Monthly Expenses

This ratio will give you a targeted amount of monetary assets needed to be comfortable for a possible emergency. If your household generates less predictable income, you need to set aside more than six months for a more significant cushion. You can use personal finance ratios as benchmarks to see how you are doing.

3. Pay Yourself First

Start thy purse by fattening

George S. Clason, who wrote The Richest Man in Babylon, is believed to have coined the term “pay yourself first.”  That means you should put away at least 10% of every paycheck into savings. Start to save small amounts working your way up to 20% of income to allocate into retirement savings investment accounts. You can distribute the initial savings to an emergency fund amounting to at least six months’ coverage for essential living costs. Unforeseen events are unpredictable and undesirable but do your planning.

Once establishing this fund, use some savings stashes to invest for retirement and taxable investment accounts. Putting away some money may be difficult at first, depending on your spending habits.

Savings should be one of the most essential parts of your household’s financial goals. Adopt a “Pay Yourself First” attitude. Your monthly budget should call for savings to be at least 10% of gross income.

Savings Ratio = Savings/Gross Income

Savings refer to money in the bank, liquid funds, deposits, money markets, and other liquid funds, such as your emergency fund. Gross income is your total source of income on your budget and includes what you earn, side businesses, bonuses, dividends, and interest income.

Your savings rate should be at least 10% of gross income. It may be challenging to do when you first start to work. As your salary or what you make rises, it should get easier to put money away for savings. A healthy savings ratio of 20% would be a bonus (pardon the pun).

4. Track Your Spending By Budgeting

Spending more than your means is a bad recipe that leads to borrowing more. It is far more profitable to save money and allocate to investments that yield 5% returns or more than having to borrow at mid-teen rates with credit cards to pay for your overspending habits. “Whoever works his land will have plenty of bread, but he who follows worthless pursuits will have plenty of poverty.” (Proverbs 28:19).

Track your spending carefully by budgeting according to your priorities. Bava Metzia 42a instructs us, “A person should always divide his money into three: one-third in the ground (for the future), one-third (invested) in business, and one-third in possession.” That may be an ancient way of splitting your funds. There are several ways to budget, such as tracking your expenses, creating a monthly budget, or using the 50/30/20 rule. The 50/30/20 budget uses 50% of aftertax or net income for your needs, 30% of net income for your wants, leaving 20% for saving money and paying off debt.

Budget In Any Reasonable Manner

Budget in any reasonable way that allows you to control your spending. It is easier now than ever to track your spending using various (free or fee) apps such as Mint, Personal Capital, PocketGuard, and YNAB for zero-based budgeting.  Alternatively, scrutinize your credit card bills and build your own excel spreadsheet.

Our spending changed dramatically during the pandemic. Our bills for grocery and household goods were higher than usual. On the other hand, we saved more from cutting out retail shopping, dining except for occasional outdoor places, hair salon appointments, gas, tolls as we stayed closer to home. While I appreciated the extra cash, I like the return to normal, even as Covid cases are rising.

5. Avoid Lifestyle Inflation

As our income grows, we often increase “essential costs,” leading to lifestyle inflation. While we are allowed the occasional latte and extravagant dinners, we need to keep our spending in check. You shouldn’t deprive yourself of everything. However, fulfilling every desire is no longer a special treat.

“Keeping up with the Jones”  and conspicuous consumption often refers to material goods we may accumulate to fit within a particular social class we admire.  We compare ourselves to our neighbors or colleagues at work.  As a result, people fall into the trap of spending on a better car or house simply to enhance their prestige and social standing. Targeting social status may be costly and divert resources better used for investing your money for more incredible long-term wealth.

It is pretty common for people to spend their raise and bonus as soon as they receive it. Temptation runs high to buy something special upon getting a raise and bonus after a year of working hard. I often bought something special to reward myself for hard work. However, you soon realize your pay hike is pretax and shrinks on an after-tax basis. If you need some things, make a list of what you believe is essential if you had some extra cash.

Overspending And Materialism

Overspending leads to materialism and lifestyle inflation that is hard to maintain. Mishlei Proverbs 13:7 tells us, “There is one who feigns riches but has nothing; one who feigns poverty but has great wealth.”  According to Psalms 128:2 “You shall eat the fruit of your effort–you shall be happy and it shall be well with you.” This text reminds me of another favorite book, “The Millionaire Next Door: The Surprising Secrets of America’s Wealthy by Thomas J. Stanley and William D. Danko.

Stanley and Danko profiled and compared millionaires in two categories: those under accumulators of wealth (UAW) and the prodigious accumulator of wealth (PAW). The UAW’s were individuals who had a low net wealth compared to their high income because of spending to maintain their status. On the other hand, PAWs managed their wealth better, often living in blue-collar neighborhoods and buying used cars. It is an eye-opening account of the good and bad money habits of the wealthy.

 6. Bargain hunting or Shopping Addiction?

Shopping is often a fun activity to do with friends or on our own. Marketing experts count on our emotions when we shop. Be aware of the biases we wear when shopping. Retail expert Mark Elwood has written about the psychological benefits of seeing bargains. He points out that stores like Best Buy use Goldilocks pricing or three-tiered pricing from low to high prices. The store hopes you will buy the middle option with higher pricing than the low-end but not necessarily feature-worthy enough to pay more.

We should not pay the list price for anything but make sure it is a real bargain. There has been a lot of worthwhile academic research about bargain hunting being a form of shopping addiction. 

There is the thrill of getting a deal,  even when we may not want that item.

Impulse Shopping vs. Compulsive Shopping

Overspending can cause financial difficulties if you are subject to impulse or compulsive shopping. There is a difference between the two though often seen interchangeably. Impulse buying happens more frequently when a consumer has a sudden urge to buy on the spot without much deliberation. We all do this from time to time. Compulsive buying, on the other hand, happens where one experiences an uncontrollable urge to buy. We may trigger negative feelings relieved by that purchase. This kind of shopping may be more like a shopping addiction that potentially needs therapy before financial hardship occurs.

7. Compounding Growth

Start saving for retirement in your 20s through your employer’s sponsored 401K plans. Deposits in small amounts in retirement accounts regularly benefit from tax advantages and compound growth over a long horizon. Automate these savings out of your paychecks. As such, your contributions are tax-deferred. Employers often match a portion of your contributions. Match contributions are extra money you can earn from your company. Separately, establish an IRA (Roth IRA) for further retirement savings. Target your contributions to amounts capped by the IRS for maximum growth for retirement. Avoid withdrawing from these accounts as you may then trigger penalties and taxes you will need to pay.

As a goal, try to contribute to your 401K plan to the maximum level, which is $19,500 in 2021.  Some years it may be hard to do, especially when you are experiencing a job loss. Resist withdrawing money from your retirement account as there is usually a 10% penalty and taxes to do so before you turn 59.5 years. Withdrawing retirement money will put a dent into your retirement fund that will be painful longer term.

One of my favorite quotes in The Richest Man is this: “It behooves a man to make preparation for a suitable income in the days to come, when he is no longer young, and to make preparations for his family should he no longer be with them to comfort and support them.”

Compounding Works Best When Investing Early

The power of compounding interest, linked to the time value of money, will benefit you the most if you save and invest early. Let your earnings accumulate and grow rather than withdraw cash from your accounts. It makes a big difference if you start saving for your retirement ten years later than your friends or if you invest for ten years and then stop contributing to your 401K retirement account. It is difficult to catch up by doubling the amount if you start investing later on.

As soon as your child is born, start saving for college through a 529 plan. These plans vary but are available in virtually every state. Like retirement accounts, they have deferred tax benefits and may have contribution limits. Check with your respective state program for details.

 8. Make Savings A Priority

Saving money is hard work and not necessarily natural for many of us. To make it a good habit, take steps to automate your savings. Most banks will allow you to automatically transfer a set amount of money from one account to another account. Your employer will be able to automatically deduct a percentage or a set amount of your paycheck to deposit into accounts such as retirement or investment accounts. Essentially, you are adopting a “pay yourself first” attitude so that you can allocate money into different buckets, especially for unforeseen expenses.

In recent years, there have many headlines about insufficient savings by Americans for years. As the outbreak of the virus caused lockdowns, most of the country stayed home. The personal savings rate rose dramatically to an unusual 32.2% in April 2020 as consumer spending dropped significantly. Over time, it will likely come down to the more normal 7%-8% range. Spending versus saving is a common trade-off with lots of tension. Motivate yourself to save by setting short-term and long-term goals proactively. Reduce spending you can’t afford. Money trade-offs require you to consider the best balance for you and your family.

Saving As A Good Habit. How Long Does It Take?

I had always heard that it took 21 days to break a bad habit. As a member of Weight Watchers, which is ALL about breaking bad eating habits (and it works for me as I am down 30 pounds and declining!), they always refer to the 21 days. However, I did not know of the 21-day origin.

Dr. Maxwell Maltz, a 1950s plastic surgeon, found that it would take his patients about 21 days to get used to seeing their new face, or post-amputation, they would still sense a phantom limb. The 21-day time frame dates back to nearly 70 years. Dr. Maltz wrote about his adjustment period to changes and new behaviors to form a new habit….”.it requires a minimum of about 21 days for an old mental image to dissolve and a new one to jell.”

More research indicates that it takes a longer time to form a new habit than 21 days. A 2009 study published in the European Journal of Social Psychology by Phillipa Lally, a health psychology researcher at University College London, indicated it took 66 days on average (in a range of 18 days to 254 days) to form a new habit.

Whether 21 days or 66 days, it takes significant time, effort, and determination to create a new habit

What About A Savings Challenges?

I have been skeptical about savings challenges. Like diets, they work for many and can be fun, especially if you do so with others. The question is whether the challenge can result in having long-term effects. I think any challenge that can motivate someone towards a good habit with lasting results has my endorsement. There are so many good savings challenges to consider. I tend to favor the 52-week challenge, which may help you build some money along with good habits. On the other hand, the no-spend month reminds me of a fasting diet and seems too difficult to attempt for most people with families or busy lives.

I often have turned to using cash only and leaving my credit cards behind. Paying for meals at restaurants or window shopping without cards has rewarded me by limiting my consumption to cash. I am not a big shopper or enjoy going into stores unless I am going purposefully for a specific outfit or electronics. My daughter, Alex, is often upset with me, encouraging me to buy something for myself. She wonders why I don’t love shopping as much as she does. Now that she is working two jobs that she loves this summer, she has become quite a hoarder herself and has asked me about my stock picks. (Okay, I am proud of her!).

9. Don’t Obsess About Money

Maintain balance in your life, and don’t just focus on wealth accumulation. According to Proverbs 21:20, “Precious treasure and oil are in a wise man’s dwellings, but a foolish man devours it.”  While no one seeks to become poor, there are dangers of solely wanting to be rich. “Keep your lives free from the love of money and be content with what you have.” Hebrews 13:5

Martin Luther King Jr. worried about the obsession with money in his famous speech called False God of Money. He said, “We attribute to the almighty dollar an omnipotence equal to that of the eternal God of the universe. We are always on the verge of rewriting the Scriptures to read, ‘Seek ye first money and its power and all these things will be added unto you,’ or ‘Money is my light and salvation, what shall I fear.”

King himself lived frugally, leaving little money for his family. However, he saw other goals like working hard, investing in education and having faith as far more critical.

Price Versus Quality

Being financially secure is important. The alternative is stressful. However, don’t be frugal for frugality’s sake. Consider price versus quality in your buying considerations. The cheapest thing may not be of the best value. Indeed, there are some items where quality doesn’t differ, and I  will pay the best price. I like buying private label products such as Kirkland sold in Costco, discounted from the branded items.

However, quality matters more when buying furniture, mattresses, a car, or a home. We have been burned by looking to get a bargain and not balancing quality. Buying solely on a price basis is foolish for these products or services that I intend to use for a while. That doesn’t mean I am averse to getting a bargain by negotiating.

10. Be Charitable

According to Jewish law, one cannot impoverish oneself by distributing all of one’s wealth to charity. However, one can leave one-third of his estate to charity in their will. A minimum of one-tenth of one’s income belongs to God per measure handed down from the Patriarchs as Jacob himself said to God, “Of all that You give, I will set aside a tenth to You” (Genesis 28:22). Giving 10% of your net income a year is a virtual goal—those who can.

According to HW Charles in The Money Code: Become A Millionaire With The Ancient Code, “Those who love people acquire wealth so they can give generously, after all, money feeds, shelters and clothes people.”

We should strive to be as generous as possible to those in need.

Final Thoughts

I found inspiration from timeless scriptures when writing this article.  Sometimes ancient words remind us that money management was always a challenge to overcome.  Choose success by your actions in saving money. 

Thank you for reading our post. Please let us know your thoughts. We love feedback. If you found some things of value, please visit The Cents of Money for other articles on our blog. Consider subscribing so you can get freebies.

 

Best 43 Quotes On This Independence Day

Best 43 Quotes On This Independence Day

Originally published on July 2, 2019, updated on June 30, 2021.

The Fourth of July is approaching, with images of fireworks, hot dogs, hamburgers, and apple pie. It is a favorite time in our household, sans the apple pie as my husband is allergic to apples. Last year was very different. Fireworks were silent due to social distancing associated with the coronavirus pandemic. Thanks to vaccinations, we are free to celebtate once again Typical events like baseball, concerts, and family reunions are back this year.

Our Fault Lines Are Very Visible And Needs Fixing

This time of year is a particularly good time to be proud of being an American despite our country’s faults. When you are raised by immigrants who loved their chosen country, freedom, security, and independence were always privileges. My mom valued being a citizen in America in her adopted country and fiercely taught me about financial freedom and independence, especially for women. 

However, fault lines have widened as realizations have sunk in that racial inequalities have not narrowed as hoped. in fact, they are reemerging and threatening our union. Peaceful protests are giving voice to needed change.

To help celebrate Independence Day this year, and every year (why not every day?) I am sharing some of my favorite quotes. You may notice that many of these quotes are apt for financial freedom and financial independence. So I took the liberty of sharing those as well. I have added new quotes to represent those who need to be heard.

Freedom and independence mean different things to different people. Today, and forever, our country needs to fix our faults. If we are to have another 244 years, we need to wipe out all our inequalities. Then we can say we are truly free as one.

America, The Beautiful

“It will be celebrated with pomp and parade, bonfires and illuminations from one end of the continent to the other.” –John Adams, Second US President

“Liberty, when it begins to take root, is a plant of rapid growth.” –George Washington

“How important it is for us to recognize and celebrate our heroes and she-roes.”  -Maya Angelou, poet and activist

Liberty

“Where liberty dwells, there is my country.” – Benjamin Franklin

“May the sun in his course visit no land more free, more happy, more lovely, than this our own country!” – Daniel Webster

“There can be no true home without liberty.” – Harriet Beecher Stowe

Power

“America means opportunity, freedom, power.” – Ralph Waldo Emerson

“It does not take a majority to prevail, but rather an irate, tireless minority.” – Samuel Adams

“America…it is the only place where miracles not only happen, but where they happen only the time.” –Thomas Wolfe, Of Time and the River, 1935 

“The essence of America-that what really unites us–is not ethnicity, or nationality, or religion. It is an idea–and what an idea it is: that you can come from humble circumstances and do great things. That it doesn’t matter where you came from, but where you are going.” – Condoleezza Rice, Republican National Convention, 2012

Let Freedom Ring!

“Those who expect to reap the blessings of freedom must undergo the fatigue of supporting it.” – Thomas Paine

“In the truest sense, freedom cannot be bestowed; it must be achieved.” Franklin Delano Roosevelt

“For what avail the plough or sail or land or life if freedom fail?” – Ralph Waldo Emerson

“All we have of freedom, all we use or know, This our fathers brought for us long long ago”. – Rudyard Kipling

“Freedom lies in being bold.” – Robert Frost

“Freedom (n.): To ask nothing. To expect nothing. To depend on nothing.” – Ayn Rand

“We must be free not because we claim freedom, but because we practice it.” – William Faulkner

Education

“Education is the door to freedom.” – Oprah

“Lock up your libraries, if you like; but there is no gate, no lock, no bolt that you can set upon the freedom of my mind.” – Virginia Woolf, A Room of One’s Own

“Freedom is never voluntarily given by the oppressor; it must be demanded by the oppressed.” – Martin Luther King, Jr.

“Freeing yourself was one thing, claiming ownership of that freed self was another”. – Toni Morrison

“Freedom is not worth having if it does not include the freedom to make mistakes.” – Mathatma Gandhi

“Freedom’s just another word for nothing left to lose.” Janis Joplin, Me and Bobbie McGee

“For to be free is not merely to cast off one’s chains, but to live in a way that respects and enhances the freedom of others.” Nelson Mandela

“He who has overcome his fear will truly be free.” Aristotle

Our Basic Rights

“Liberties aren’t given, they are taken.” – Aldous Huxley

“It is by the goodness of God that in our country we have three unspeakable precious things: freedom of speech, freedom of conscience, and the prudence never to practice either of them.” – Mark Twain

“If I follow the inclination of my nature, it is this: beggar-woman and single, far rather than queen and married.” – Elizabeth I, Collected Works 

Women

“I do not wish them [women] to have power over men; but over themselves.” – Mary Wollstonecraft

“My own sex, I hope will excuse me, if I treat them like rational creatures, instead of flattering their fascinating graces, and viewing them as if they were in a state of perpetual childhood, unable to stand alone.” – Mary Wollstonecraft, A Vindication of the Rights of Women

“I’ll walk where my own nature would be leading, it vexes me to choose another guide.” – Charlotte Bronte, Jane Eyre

“People have only as much liberty as they have intelligence to want and the courage to take.” – Emma Goldman

“I think the girl who is able to earn her own living and pay her own way should be as happy as anybody on earth. The sense of independence and security is very sweet.” Susan B. Anthony 

Financial Freedom and  Independence

“The highest pleasure to be got of freedom and having nothing to do, is labor.” – Mark Twain

“Everything that is really great and inspiring is created by the individual who can labor in freedom.” – Albert Einstein

“For it is in your power to retire into yourself whenever you choose.”  – Marcus Aurelius, Meditations

Erasing Inequalities For Once And For All

“To bring about change, you must not be afraid to take the first step. We will fail when we fail to try.” Rosa Parks

“Prejudice is a burden that confuses the past, threatens the future, and renders the present inaccessible.” Maya Angelou

“Without a struggle, there can be no progress.” Frederick Douglass

“There is no such thing as race. None. There is a human race–scientifically, anthropological.” – Toni Morrison

“Not everything that is faced can be changed, but nothing can be changed until it is faced.” – James Baldwin

“To suppress free speech is a double wrong. It violated the rights of the hearer as well as those of the speaker.” – Frederick Douglass

“I see what’s possible when we recognize that we are one American family, all deserving of equal treatment.” – Barack Obama

Gratitude

“Let not your mind run on what you lack as much as on what you have already.” – Marcus Aurelius

“All good things are wild and free.” – Henry David Thoreau

“Men spend the best of part of their lives earning money in order to enjoy a questionable liberty during the least valuable part of it.” Henry David Thoreau

“Someone’s sitting in the shade today because someone planted a tree a long time ago.” Warren Buffett

Related Post: Gratitude Can Lead To Better Finances

 

America’s Greatness

“It’s never paid to be against America. We come through things, but it is not always a smooth ride. Warren Buffett

“From a standing start 240 years ago–a span of time less than triple my days on earth– Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants and the rule of law to deliver abundance beyond any dreams of our forefathers.” Warren Buffett, 2016 Shareholder Letter to Berkshire Hathaway Shareholders

I have as big an obsession as Warren Buffett appears to have when it comes to prosperity and his gratitude to our country.

Thank you for reading! Do you have any favorite quotes on Independence Day? Please share them with us! Enjoy your holiday! Stay healthy!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

What You Need To Know About A Sinking Fund

What You Need To Know About A Sinking Fund

We all have something special we’d like to buy for our home or in life. That old couch that has seen better days in your living room begging for a replacement or a vacation you thought about for a long time but keep pushing off because it is too costly. Paying for these significant expenses can be challenging for us, but a sinking fund may pave a better way.

Sinking funds can be a gamechanger for individuals and households. It is a valuable tool to add to your financial toolbox for savings. This strategy helps those who want to manage their finances better and gain peace of mind.

The timing for setting up sinking funds could not be better. Americans have been saving more, as illustrated by the US personal savings rate of 14.9% for May 2021. The unusually high rate due to pandemic-related spending constraints compares to 7.6% at the end of 2019. So why not make your savings work better for you?  Setting up a sinking fund is easy to do and enhances your ability to save money for large purchases you will make in the future.

What Is A Sinking Fund?

Sinking funds have long been helpful for companies and bondholders to minimize risk. For example, when corporations need to raise capital, they may issue a bond that matures in 20 or 30 years. Bondholders receive coupons semiannually and the principal (their investment) at maturity.

Many bonds now have a sinking fund managed by a trustee who oversees the fund. Money is set aside periodically with a trustee for repayment of the portion of the principal. This action eliminates the need for a significant cash outlay for the company at maturity.

There is less risk of the company defaulting by using the fund if it doesn’t pay back the principal to bondholders. The fund adds protection and security for the bondholder that the company can pay off their debt. A sinking fund allows a company to raise capital with a lower interest rate to bond investors. As such, it improves a company’s creditworthiness.

A Sinking Fund For Your Household

Similarly, you or someone in your family can create a sinking fund, dedicating a savings account for a specific household expense that may be too large to handle without borrowing the money. We will explain later how your sinking fund differs from your emergency fund.

Once you determine what you want, say a new couch for $1,000-$1,500 for your living room, your sinking fund is for the sofa, not for another expense. You intend to save money to buy a couch, making monthly contributions to the “couch” sinking fund. Everyone has their budget, lifestyle, and timeframe for getting the couch or whatever it is you are targeting.

With a bit of planning, you can have what you need or want in your life without guilt. If you have your heart on a particular $1,500 couch within a year (i.e. 12 months), your monthly savings goal is to contribute $125 to the sinking fund each month.  Break the estimated spending amount into the monthly savings you plan to deposit into the respective savings account.

Without a fund, there is a greater temptation to pull out your credit cards for these large purchases. Your challenge is that you would have to pay your card balance in full or face a card balance growing on a compound basis at high-interest rates. There are more benefits to setting up a sinking fund for purchases than the downside of adding to your debt.

Sinking Fund Vs. Emergency Fund

Both your sinking fund and emergency fund are safety nets but for different purposes. An emergency fund is for the money you set aside in a savings account for unexpected costs you may face when losing a job, boiler breaks, a medical necessity, or pet surgery. Emergencies, by definition, are unknown as to timing and amount needed. You still have to pay bills, rent, or mortgage. Unplanned events happen, upsetting your finances. We recommend having your emergency fund cover six months of your basic living needs. You want to have access to liquid assets quickly.

The sinking fund is for saving money for a known purpose you expect to purchase in the future. Typically, your sinking fund is for a specific planned amount. You know its timing and have been saving for it. The point of having a sinking fund is not to tap your emergency money or a general savings account.

Just like you have loans for a house, car, and college, you are earmarking savings for larger items you want to purchase. Dollars are fungible and can go into a “car or house down payment” sinking fund. You can have a sinking fund by categories such as a house, car, vacations, Holidays, Christmas gifts, or charities. Alternatively, you can name these reserves by being more specific:

  • Kitchen remodeling
  • Sofa
  • Flat-screen TV
  • Refrigerator
  • Car maintenance and repairs
  • Down payment for Car
  • Down payment for House
  • Pet bills
  • Taxes
  • Vacations

Labeling the sinking funds is a personal decision based on your household and its relevant savings goals. 

How To Set Up Your Sinking Fund

 

1. Review Your Budget

Before setting up your sinking fund, you should a good grasp of your household’s budget. Budgeting is an essential tool for understanding your income sources less fixed and discretionary expense categories. Fixed living costs include your rent or mortgage, utilities, loan payments, and savings. You should have “savings” on your budget for when you are paying yourself first. Depending on how granular your budget is, you should separate line items for an emergency fund and the sinking fund. Pick a budget method that works for you.

When it comes to fixed costs,  you have less flexibility to reduce amounts. On the other hand, discretionary spending varies based on money left over.  You can learn more about different budgeting approaches here.

2. List Your Planned Purchases

Make a list of fund categories, break them down into more specific items. Then determine the target amounts for each. Name your sinking fund by its discreet type. Some funds may have higher amounts and longer timeframes. Divide each type total by the numbers from the planned purchase time. For example, if you are saving up for a new car’s down payment in two years, estimate the cost of the car is, say, $38,000, so you would want around a down payment of  $4,500. That equates to about $190 of the planned monthly contributions for two years or 24 months.

There is no set number of sinking funds though I would caution you about having too many sinking funds to manage.  This process is about organizing your finances to make things more effective and efficient for you. As in the sinking bond for businesses, you are the trustee or manager of the funds.

3. Where Your Savings Will Go For Purchases

You can open an FDIC-insured saving account for each type or have one large sinking fund with named sub-accounts. Keep in mind that the sinking funds are separate from your emergency fund and savings accounts. The type of accounts you should look for should be readily accessible and liquid, similar to the account you use for an emergency fund.

When you open a sinking fund for each type, each of your accounts differs from target amounts and timeframe. For example,  when you are saving money for a house makeover or a down payment for buying a home, you probably are looking to build a five-figure money chest. If so, you can look for higher-yield savings or a money market account. For smaller purchases and shorter timeframes, avoid accounts that require minimums that penalize you with fees for not maintaining a specific balance.  Essentially, you want safety and liquidity for the sinking funds.

Use Sub-Savings Accounts

Some banks, such as Ally, allow you to have a savings account and sub-savings accounts when you have multiple savings goals for concrete purchases.  You can automate transfers to each of your sinking funds based on varying monthly contributions. Having the ability to transfer money can ease the process for you. However, you will be receiving more monthly statements.  Consider the account details regarding fees, minimums, if APYs are different, and whether this works for you.

4. Need An FDIC-insured Account

Whatever you decide to do, each sinking fund should be in an FDIC-insured savings account that is readily accessible. For longer-term purchases, look for higher yields and minimize fees you may have to pay.

Benefits of A Sinking Fund

 

1. Better Budgeting

When you have a good understanding of your budget, your fixed living costs, it is easier to plan for discretionary spending. You can decide what amount you can contribute to your specific sinking fund each month without becoming a hardship.

The better your budgeting, the better you can plan for your savings goals and spending. It is easier to save money when you have an intended target to set money aside for that purpose.

2. Conscious Spending

When you set up your sinking fund, you essentially are planning to buy something you need or want for your home or life. It is an act of conscious or mindful spending when you are intentionally saving for something. You know the specific couch you will buy, have a plan, and focus your attention on that couch.

By taking time and doing comparison shopping, it is less stressful and more enjoyable anticipating the arrival of something new that you specifically want to get. You are not at that stage where salespeople will push you into an impulsive purchase you’ll regret. You are more in control of your spending and more likely to negotiate where and when possible.

3. Delays Instant Gratification

The need for instant gratification is all around us, with social media ads tinkering with our brains. The present bias plays a significant role in our leaning toward immediate pleasures. It causes us to favor the present over the future with immediate rewards. With effort, you can counter tendencies to overweight decisions that can cause overspending with planning.

With your sinking fund in place and growing closer to your spending goal, you can delay instant gratification. You have your mind not just on your expected purchase but on other things as well. Setting goals for one part of your life makes you more purposeful about your needs and wants. Achieving something on your list can be very fulfilling.

4. Avoids Adding Debt

Overspending can lead to higher debt, significantly rising credit card balances. Card balances are especially higher cost and challenging to handle. As in the sinking fund for corporate bonds, a household sinking fund can help us avoid reaching for our credit cards to pay for large ticket items. Increasing our monthly savings by earmarking money to contribute to a specific account that earns interest is the path to better financial health.

Saving first, spending later, and avoiding debt where we can, can improve our creditworthiness.

5. Peace of Mind

Having peace of mind is priceless. While you may not be able to get rid of every stress you have, planning out expenditures for important things you want to get or do can help your mindset.

Drawbacks

 

1. Don’t Have Too Many Sinking Funds

You may get good at organizing your finances. The next thing you know, you have too many sinking funds, overlapping purposes. That reminds me of an ad for Post-It notes, stating that they should be used “for the little things you’ll forget,” and then you see yellow Post-Its all over people’s foreheads. You get the picture. You don’t want to create chaos. The sinking fund process should help to organize where your savings should go.

2. Sinking Funds Are Not Interchangeable

When creating sinking funds, they are separate from each other. Keep contributing to each based on the estimates you determined. Try to label them as discreetly as possible, so it is not confusing to you. If you wanted a couch and estimated $2,500 for it, but found the one you love for $1,800, then you can reallocate your savings to other areas. Sometimes you under or overestimate the expected cost, so make changes but don’t blur the lines.

3. Keep Emergency Funds Separate

Having an emergency fund is essential, and its purpose is different from any sinking fund. Don’t transfer funds from your emergency account to your vacation account. That’s cheating, and if an emergency arises, you want that fund to be there for you in its safe and sound place.

4. Don’t Forget Savings For Other Goals

Saving for retirement and investment accounts is vital for your long-term future. Make sure to automate contributions to your 401K retirement plan, if sponsored by your employer, and for your Roth IRA. You should contribute some of your savings to investments, whether you are managing the account or you have a financial adviser to do so.  Over the longer term, these accounts grow faster than savings bank accounts, depending on your respective investments (i.e., stocks, bonds, real estate), and benefit from compounding growth.

Final Thoughts

Establishing sinking funds by saving for large purchases can be beneficial. It is a terrific organizational tool that enhances your mindfulness. By being thoughtful about your spending, you will reduce your need for instant gratification while reducing your buyer’s remorse.

Thank you for reading! If you enjoyed this article, please visit The Cents of Money for more articles of interest and subscribe for freebies, including our newsletter.

 

 

 

 

 

How to Choose A Financial Advisor

How to Choose A Financial Advisor

“A goal without a plan is just a wish.” 

Antoine de Saint-Exupery, The Little Prince

 

“When it is obvious that the goals cannot be reached, don’t adjust the goals, adjust the action steps.” 

Confucius

When you are seeking a financial professional, you may be confused by your choices. Many professionals help you with planning when giving you financial advice, whether making investment recommendations for your portfolio or providing tax-efficient savings.

“Financial planner” or “financial advisor” are terms often used interchangeably. They may provide similar financial planning services. However, their level of education, certifications, designations, and standards may be quite different. This post discusses how to choose a financial advisor that is right for you.

The Main Differences When Seeking A Financial Advisor

 

1. Type of Personal Financial Services You Are Looking For

You may be looking for someone to advise you for a single purpose like debt management or a comprehensive plan. Here, we will focus on how to choose a financial advisor or planner. This type of advisor can handle various services (discussed below) to guide you towards your goals strategically. At the end of this article, you should be able to hire a financial advisor.

You may turn to accountants and attorneys for setting up a new business, debt management, bankruptcy, taxes, and estate planning.

2. The Fee Structure

Generally, your fees range from the fee-based only, commission-based, flat fee, or a blend of fees and commissions. However, there may be extra costs for additional services such as insurance.

3. Education, Certification, and Designation Requirements Vary

Financial advisors or planners have a bachelor’s degree with an accounting or finance focus as the minimum requirement. Advanced educational degrees are not uncommon. Their course of study distinguishes certified financial planners (CFPs), with a rigorous exam, required experience, and high standards.

Consider your candidate’s soft skills such as adaptability, communication, and problem-solving and if you have good chemistry. We have a list of questions below you should ask your candidate when choosing your financial advisor.

 4. How They Are Regulated

Different regulators play a role according to the primary designation. Regulation of financial planners may be according to their professional title. Planners with CFP credentials are subject to the requirements of the Certified Financial Board of Standards.

The Securities Exchange Commission (SEC) and the state where they do business regulates investment advisors who provide financial planning.

The  State Board of Accountancy regulates the accountant preparing a financial plan.

Key Financial Services

 

1. Money and Debt Management

Consider a money coach or credit counselor when you need help saving money, setting up a budget, reducing expenses, and debt management. You can often get free assistance from a certified credit counselor by searching on the nfcc.org website.

Accredited financial counselors or AFCs can aid you in money management through their organization 

 

Related Post: How To Pay Down Your Debt For Better Financial Health

2. Investment Advice and Trades

Investment advisers and brokers provide all manner of investment services, from do-it-yourself online trading to full-scale investment advice and money management. Generally, investment advisors and broker-dealers need to register with the SEC and the Financial Industry Regulatory Authority (FINRA), and state regulators. They are subject to the suitability standard, less demanding than the fiduciary duty.

A Registered Investment Advisor (RIA) advises high-net-worth individuals on their investments and manages their portfolios. They have a fiduciary duty to their clients, which means they provide investment advice by acting in their clients’ best interests.

3. Financial Planning

Financial planners are financial advisors who provide clients with a range of personal financial services. They can help you create a simple one-time financial plan if you are just starting, grapple with a specific financial objective, or provide a comprehensive goal-based plan. The latter may encompass savings, investments, college savings, insurance, retirement, tax planning, and estate planning.

Each plan should be tailored to your needs and provide a disciplined approach to achieve your financial goals. Financial planners will want to gather data from your personal and financial life and make forecasts to achieve wealth. Hiring a financial planner is a good starting point when you are in the early stages of accumulating assets or already have substantial assets but need guidance in their complex financial situation.

A core financial plan includes:

Cash flow management will look at the specifics of your current and projected budget and net worth, debt management, creating an emergency fund, savings for a house, vacations, college tuition, and retirement.

Risk management will consider life, disability, and medical insurance protection for you and your family.

Wealth management will address investments, diversification, risk tolerance, and asset allocation.

Related Post: 10 Tips To Diversify Your Investments

Tax and retirement planning should provide strategies to minimize your tax burden using capital gains strategies, charitable giving, tax-free and tax-deferred retirement savings. Advisors should speak with their clients about what kind of lifestyle they expect for their retirement years.

Estate planning involves questions about wealth transfer to loved ones most appropriately and efficiently.

Related Post: Your Guide To Basic Estate Planning

This Designation Is Preferable

Certified Financial Planners, or CFPs, have an essential designation issued by the Certified Financial Planner Board of Standards. This designation is difficult to obtain. It requires passing rigorous exam testing in specific personal finance areas. The CFP certification is distinct from CFAs, also or certified financial analysts who are highly respected in the investment analysis field.

CFPs must commit to continuing education on financial and ethical matters. They need at least three years of experience and must adhere to pretty stringent standards to earn and maintain their title. Before hiring a financial planner, you should verify the status of anyone claiming to be a CFP and whether he/she has undergone a disciplinary process.

When choosing a financial planner, CFP credentials may provide added comfort and confidence in your choice. However, it is not a guarantee of excellent performance. You want to pick the right financial advisor or team with the right fit for your needs.

Look For A Fiduciary

At a minimum, you want planners who are experts, professional and trustworthy. You should pick your planner who adheres to the fiduciary standard. The fiduciary standard is a higher standard requiring the planner or investment adviser to act in the best interests of their clients at all times.

Fiduciary duty standard is the highest standard of care referring to the financial professional.  A fiduciary is someone who holds a legal and ethical relationship with clients. They manage people’s money in their clients’ best interests rather than in their interests.

Registered Investment Advisors or RIAs help you manage your assets, mainly by way of your investment portfolio. These professionals are knowledgeable about market patterns, investing in stocks, mutual funds, and other securities. They are fiduciaries making similar recommendations to a CFP. Their pay structure is fee-based but earns commissions from the sale of financial products. CFAs or chartered financial analysts are highly respected in the investment analysis field, distinct from financial advisors.  

Don’t Paint Advisors With A Broad Brush

Investment advisers and brokers who work for broker-dealers and offer investment advice are primarily commission-based. They may have obtained CFP credentials through the hard work required.

From my experience, you cannot paint these individuals with a broad brush. Many are product salespeople interested in selling the latest service from their firm, yielding commission dollars. Other advisors are problem-solvers for their clients, helping them to manage their assets as a business. If you are fortunate to find one of these value-added professionals, grab them.

In contrast to the stricter fiduciary standard, FINRA requires the suitability standard for financial professionals who work for broker-dealers. Suitability is a lower standard than the fiduciary standard, which means the financial professional should only make recommendations suitable for their clients. A recommendation doesn’t have to be consistent with the individual’s objectives and profile.  For example, buying risky securities would not be suitable for retirees.

Financial Planners With Specialities

You may be seeking a financial planner for a specific goal like buying a house, retirement planning, or estate planning. Some planners specialize in particular areas such as addressing families with special needs, women executives or planning for single people.

Related Post: 10 Ways For Women To A Financial Independence

Look For Fee-Based Only Planners

The pay structure differs for different financial professionals from fee-based-only or charging flat fee, commission-based only, or a blend. When you want to develop a financial plan, I recommend seeking a fee-based adviser with more incentives to help with your financial goals. Fee-based structures can be fees by the hour, a flat fee for your plan, or a percentage of your annual assets.

Hourly rates may be in the $100-$400, with one-time financial plan costs of $1000-$3000+, and annual fees of percentages ranging 1%-2% of assets under management (AUM). Finding a planner that charges a flat rate or by the hour is best for those just starting to make money, who want a simple financial plan, and don’t yet have many assets.

Alternatively, you may want to consider Robo-advisors, such as Betterment, Wealthfront, Vanguard Personal Advisor Services, and  Schwab Intelligent Portfolios. Robo-advisors are an excellent option for those seeking low-cost financial advice and zero account minimum.

These providers have a range of investment and retirement planning services, digital planning tools and may provide access to human financial advisors. Their management fees vary from 0.25%-0.50% or flat annual fees. Some people prefer a human financial advisor for a specific part of their financial plan and several Robo-advisors offer blended services for a higher fee.

It Depends On Your Needs

You may be seeking a one-time financial plan after getting a sizable bonus or an inheritance. Others want to have a planning team to be able to work with them on an ongoing basis. There are a plethora of financial strategies to handle for a family moving through changing life cycles.

Trustworthy financial planners can help you build wealth with a disciplined approach. They may help you alleviate the financial stresses that you encounter when saving for a house, college tuition, insurance, and retirement using the most tax-efficient strategies.

When you have a busy career earning a high income, it may be challenging to wrestle with these personal finance specifics. Paying $10,000-$20,000 annually on a $1-$2 million portfolio that may produce savings isn’t bad.

Many traditional financial planners require a minimum of assets to invest, usually in the $250,000 range or significantly higher, and may not work with you. Other planners may prefer to grow with beginner clients to add a lot of value, particularly as clients have expanding family needs.

Where To Find The Right Financial Planner

The National Association of Personal Financial Advisors (NAPFA)  are fee-only planners who adhere to the fiduciary standard. They accept no commission-based planners. Their standards are high and generally meet or exceed the requirements needed for CFP credentials. Ask your friends and colleagues if they would recommend someone to you.

If you are just starting with fewer initial planning needs, you may consider the Garrett Planning Network. They are certified financial planners or persons working towards obtaining their credentials. They tend to focus on smaller projects for an hourly fee.

XY Planning Network is relatively new, focusing on young professionals looking for fee-based financial planners with the CFP designation. Their organization serves Generation X and Millennials. Their fees appear to be within the ranges of hourly rates or flat fees.

There are great Facebook Groups to visit, such as Females And Finance, run by Sheryl Hickerson, to help you find the right person for you. Women, in particular, have distinct needs for financial planning.

Do I Need A Financial Planner?

You can develop a simple financial plan on your own as you are starting. Even if you do not work with a financial planner, you need to consider your short-term and long-term goals. Managing money well is time-consuming and requires expertise in many areas.

As your assets grow, you may need guidance and assistance in developing financial strategies.

 10 Questions You Should You Ask When Seeking A Financial Advisor

Professional Caliber

  1. What are your qualifications, credentials, and experience?

You will want to know who you are dealing with in terms of expertise, education, certifications, and experience.

  1. Do you work with a team, and how do you work together?

Financial planners often have their specialties and overlap with others who can complement their skills.

  1. Are you a fiduciary?

A fiduciary standard is a more stringent duty of care. When speaking to a professional financial candidate, you want to understand how they view their role to you. It is your money and your financial future. You want your advisor to be working on behalf of your best interests, not theirs.

What Does This Cost

  1. What are your fees, and what are my costs all-in?

Understand their fee structure. Be clear about the extra costs you may incur, such as buying an insurance policy.

  1. How will I be communicating with you and your team?

Biannual plan reviews are common. How often will they be reviewing your financial plan with you?  If you will have an ongoing relationship with your financial planner, it is essential to understand how you will review and update your plan. What kind of communication should you expect, particularly when you are making changes.

  1. How will they work with you?

Will they take the time and have the patience to explain complex concepts to you. This information does matter, and it may take time to build confidence and a good rapport.

Characteristics of Your Financial Planners

  1. What is your investment philosophy? You want to understand your planners’ fundamental beliefs regarding growth and value investing. Markets can be turbulent, so you need to know how they may address investments during recessions.
  2. How should I measure success in our financial plan?

You need to understand the benchmarks that will provide you with results relative to your financial goals. There may be different measurements for various aspects of your plan.

  1. What added value may I expect from you as our financial advisor?

This question is tricky. Of course, you should expect expertise, professionalism, and trust. You want to know what kind of relationship you will have. When you want to make an investment that advisors believe is not a sound one, will they tell you “No”? They must have your back.

  1. What are some of the criticisms your clients say about you and your team?

No one person is perfect, so knowing those criticisms will help you measure your prospective financial planner and how he/she fits with your needs.

Final Thoughts

Prudent financial planning is vital to achieve your short- and long-term goals and to support your family values. We outlined the characteristics of a financial planner or advisor, the varying fee structure, and how to pick the right financial advisor for you.

What are you looking for when seeking out a financial advisor? What traits are essential to you? We would like to hear from you!

Thank you for reading! Please consider subscribing to The Cents of Money blog and get our weekly newsletter.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

21 Surprising Tips To Know Before Buying A House

21 Surprising Tips To Know Before Buying A House

 

things to know before buying a house

Are you getting ready to buy a home? 

Your first (or even fifth) house purchase is a huge decision. It seems like there are a million things to know before buying a house.

From figuring out how much you can afford to hire the right home inspector, there is a lot to keep in mind.

In order to help you with your home-buying checklist, I interviewed 21 different experts on the top thing they wish they knew before buying their first house. Their answers uncovered a few surprising things even I hadn’t considered!

Read on for the top 21 tips for new home buyers.

1. Hire a Home Inspector

Ryan Luke from Arrest Your Debt says:

A good home inspection will cost you several hundred dollars. When you are already spending so much money, it may be difficult to write another check for a professional to inspect your home.

However, not inspecting the home professionally can have costly consequences. Home inspectors come into the property and take a deep look at everything — the landscaping, wiring, appliances — plumbing, and the roof — before you sign the contract.

Home inspectors can find these problems, and you can either have the seller fix the problems or pull out before you’re stuck with a problem property.

2. Keep the Hidden Costs in Mind

Melanie Allen from Partners in Fire says to think about the hidden costs:

The cost of a home is far more than the purchase price. I wish I would have taken into account how expensive everything else is when budgeting for my first home.

I didn’t think about how much homeowners insurance would add to my monthly bills, or that I would have to furnish my first home from scratch. Remember to consider things like moving expenses, furnishings, closing costs, insurance, taxes, HOAs, and any other hidden expenses of buying a home when first creating your budget.

This will prevent you from getting a nasty surprise that you can’t afford when you should be excited about your new home.

3. Renting Back Isn’t Always at Market Rate

Monica Fish from Planner At Heart warns about lease-back agreements:

In a competitive real estate market, buyers are doing all they can to become “The Chosen One,” including allowing the sellers to stay in the property and rent it back from the buyer for a set amount of time after closing. While you want to make your offer as competitive as possible, keep in mind it’s customary to charge a daily pro-rated portion of your PITI payment (Principal, Interest, Taxes, and Insurance), not the market rate.

So if your PITI is unusually low due to a large down payment or they’ll be renting from you for months, you might want to consider a separate rental agreement based on current rental rates in your neighborhood. We certainly wish we did.

4. Be a Stay at Home Landlord

Brian Thorp from WealthTender wished he had thought about his purchase as an additional income stream:

Mortgage payments can feel intimidating, but especially if you’re buying a house while living alone, it’s easy to offset your mortgage (or even make money each month) by renting a room or your entire house on Airbnb during major events.

I wish I had subscribed to a few real estate blogs before buying my first house as I would have discovered ideas like this one sooner to save money or even pay off my mortgage early.

5. Home Improvement is Expensive

Jeff Cooper from Have Your Dollars Make Sense learned some lessons about home improvement costs:

Many people will buy a fixer-upper when buying a home to save on the initial cost thinking they can simply put money into the home when they can. It is a solid strategy, but many fail to realize how much home improvement can be. Most of us want to fix everything quickly, but fail to realize how much even the smallest of updates can be.

When buying a fixer-upper make sure there isn’t too much to fix!

6. Think About the Future

Derek Carlson from The Money Family suggests thinking about your future plans before buying a home:

Consider your future plans and if this home fits in with them, or if you’re willing to move in 5 – 10 years. If you’re planning on starting a family or changing jobs, will this home fit into those plans? Or will it require you to relocate to another part of town with a different commute, different school district, etc.?

Selling a house and buying a new one is expensive. By planning now for a house you can grow into you can save a significant amount of money down the road.

7. Aggregate Your Paperwork

Sanjana Vig from The Female Professional says:

There are many things to consider when buying a house. While I did all my calculations before taking the leap, I underestimated the amount of paperwork that would be required for the bank.

For example, I had, over time, transferred my down payment into my main checking account. For each transaction, I had to explain where the money came from. In retrospect, I wish I had done the transfers earlier, or in one lump sum so that I could have avoided the headache of phone calls, paperwork, and explanations.

Do yourself a favor and tee up all of your accounts so that you can skip the questions. You’ll save yourself a lot of time and stress!

8. Ask About Warranties

Jessica Bishop from The Budget Savvy Bride wishes she had collected more information on appliance warranties:

Before you buy a home, you’ll want to learn about the history of all the major appliances and if there are any existing warranties. From kitchen items like your refrigerator, oven, and dishwasher, to laundry machines, or even your HVAC unit or water heater, you’ll want to know what’s still within a warranty period and what’s not.

It’s also helpful to know the age of your water heater or air conditioning unit in particular because these costly items generally have to be replaced at regular intervals. If you’re coming close to the 10-year mark on a water heater, you might just find yourself hit with a major emergency plumbing expense right after you move in, so it’s good to be aware of any potential risks ahead of time.

9. Know How Much You Can Offer

Riley Adams from The Young and the Invested offered this advice:

My wife and I recently purchased our first home together, and we, fortunately, decided to contact a lender out of an abundance of caution to understand what our budget would be.

Initially, we thought a larger home with a higher price tag was within reach, however, after learning about the rules for measuring your debt to income ratio, not all of our income would count in that equation. Banks, who tended to be more conservative during the pandemic, only counted certain types of income, making variable income not receive credit in that metric. As a result, we had to lower the range we could afford on a home.

Thankfully, we still found our dream forever home and it didn’t hold us back too much. If anything, it added discipline to our ability to bid. If we had more firepower, we may have opted to use it. We knew buying a house would be one of the best assets to invest in for our part of the country and wanted to find the right one for us to settle down and see appreciation over time.

10. Your House Is Not a Part of Your Retirement Fund

Jesse Cramer from the blog The Best Interest wishes he had considered the impact of his home on his retirement plans:

I was excited to buy my first home because I saw it as a vehicle to build my wealth. And that’s largely true. Real estate is a significant stepping stone in building the average American’s net worth.

But wealth is not the equivalent to your retirement savings, and that’s where I messed up. You cannot both live in your house and sell it as part of your retirement nest egg. Duh! I know, I know, but it’s a mistake I made.

The truth is that you should only count real estate as part of your net worth if it’s not your primary home or if you plan on downsizing prior to retirement. Otherwise, you’re selling yourself a false dream!

11. Consider Furniture in Your Closing Costs

Kevin from Just Start Investing gave the following advice:

Furnishing a home can cost a lot of money, and oftentimes that is an overlooked expense when buying a house. It’s important to consider your furniture budget when looking at your overall housing budget, keeping in mind are needs vs wants.

Remember, you don’t have to fill your entire house right away. Be realistic with your budget and stay within your means.

12. Take Advantage of First-Time Home-buyer Loan Programs

Jonathan from Parent Portfolio added:

Some loan programs allow first-time homebuyers to make a down payment as low as 3% to 5% of the purchase price. Instead of buying a single-family home, consider purchasing a duplex or another multi-unit.

Homeowners can house hack by living in one unit and rent out the other unit(s) to tenants. The rental income can cover the mortgage payment and allow a homeowner to live mortgage-free.

Usually, real estate investors have to pay a 20% to 25% down payment for non-owner-occupied properties. Therefore, a 3% to 5% down payment is a great deal with the benefits of living for free and making extra income.

13. Purchase Price Should be Based on Monthly Affordability

Tawnya from Money Saved is Money Earned advises that the monthly payment is more important than the purchase price:

If you are financing your home, which most are, there are several factors that can drastically affect your monthly payment.

These factors include property taxes, mortgage insurance, homeowners associations fees, and the interest rate you’re able to secure. While your interest rate will likely be the same for each house you consider, the other factors can swing your monthly payment several hundred dollars one way or the other.

Instead of setting a budget at the purchase price of a home, you should instead set a monthly budget when determining the affordability of a house. If you’re pre-approved or working closely with a lender, have them give you a rough estimate of the monthly payment for each home you’re considering to ensure your monthly budget isn’t overstretched.

When I was looking for a home there were several that were within my overall purchase price range that ended up being outside my monthly affordability due to property taxes or one of the other factors discussed.

14. Hidden Fees Add Up

Adam from Wallet Squirrel says to pay attention to the hidden fees:

There are some hidden fees on top of the property taxes and insurance we didn’t know about when we bought our first home.

One example is the sewage and storm-water fee. This isn’t huge because it is only about $250 a year but it is another check to write. I wish I had known to check with the county and city for fees like that.

I would recommend talking to your real estate agent about any county or city fees that might sneak up on you. They should have the resources to help you research.

15. Remember to Budget for Legal Advice

Tim Thomas offers some advice on understanding legal fees in the buying process:

Here in the UK, when it comes to legal advice concerning buying property, the quality of the service you receive and the fees they charge can vary significantly.

In hindsight, we were lucky in finding someone for our first purchase who we used for future purchases, but he wasn’t available on our last house buy. The costs for this last purchase escalated significantly from the initial quote, and it was for things that our preferred lawyer wouldn’t have charged us for.

So get a clear handle on the legal fees you’ll be charged and what is and isn’t included in that price.

16. How to Budget for Maintenance

Josh Hastings from Money Life Wax emphasizes the importance of budgeting for regular maintenance:

Truth be told, when I bought my first home I had no clue that within a few years my A/C unit, washing machine, stove, and dishwasher would all need replacing.

I wish I had budgeted for all of these big-ticket items. After talking to my financial planner, his recommendation was to save 1% of my home value per year for home improvement and maintenance costs. For example, a $300,000 house means you want to set aside $3,000 a year to be safe.

This will help for even bigger projects such as siding, plumbing, or windows.

17. Get Your Finances in Order Before You Buy

Marjolein from Radical FIRE recommends doing a financial check-up before you start looking for a house:

Before you buy your home, you want to make sure that your finances are in order. You can do that by making sure that you’ve paid off your high-interest debts, and you want to have an emergency fund, to name a few examples. Getting your finances in order looks different for everyone, so think about what it means for you and start to take action.

I was in a situation where I wanted to buy a house, and I was in the process of talking to the bank. That’s when I found out that I couldn’t afford the home because of my debt. There are regulations in place in the Netherlands, where your debt influences the amount of mortgage you can get. It didn’t matter that I had a high average net worth in the Netherlands.

If I knew that before, I would’ve started by paying off my debt, and I wouldn’t have wasted my time. Get your finances in order and you’ll be able to buy a home with peace of mind.

18. The Value of Adding Value

Tyler Weaver of Relentless Finances says you should consider ways to add value to get the most bang for your buck:

When buying my first house, I was looking for something of great quality that was ready to go.

As I learned more about real estate, and myself, I realized I prefer to buy a house that needs a little work. On my second house, I took on a much more extensive renovation and was able to capture a lot more equity.

Building equity through renovations is a core principle to the BRRR method which I now do on rental properties.

19. Don’t Overlook Your Wish List

Amanda Kay from My Life, I Guess reminds you not to compromise on your wish list just because of a hot market:

Although I am still a renter, I kind of hate where I live. Not being able to move somewhere better used to really bother me, but as my husband and I are getting closer to buying our first home, I see it as more of a blessing.

I know exactly what I would change about our current home, and my wish list is ready for when we start looking. More importantly, though, is the list of deal-breakers that I have been able to pinpoint and will avoid, so I don’t end up stuck owning a home that I don’t want to live in.

20. Shop Around for Insurance

Robyn from A Dime Saved says:

Insurance costs and needs vary wildly from state to state and area to area. Ask neighbors of the house you want to buy about approximate insurance costs and consult with an insurance agent to find out if you are in a listed flood or zone.

Even if you are not required by the bank holding the mortgage to purchase special supplemental insurance (fire, flood, hurricane, earthquake, etc) you may want to look into purchasing them for your own peace of mind.

Make sure to have enough money in your emergency funds to cover your insurance deductible so you are covered in case of an emergency.

21. Be Aware of Your Own Biases

Linda from The Cents of Money says self-awareness is key in the buying process:

The most reasonable people may become irrational when buying their first home. Biases like the confirmation bias may cause you to be swayed by an eager real estate agent doing their job. As they highlight the best features during the home search, you may overlook negative factors that are more crucial to you, like the tiny kitchen, cracked walls, or low ceilings.

Make sure to revisit the house at different times and honestly appraise what may later become significant problems.

Final Thoughts

There are a lot of things to know before buying a house. By being aware of these tips, I hope it helps you become more prepared for your own home purchase.

Educating yourself before jumping into a big purchase will help you make a better decision, and be more confident in the outcome.

Thank you for reading! What are your best tips for first-time homebuyers? Let me know in the comments!

This article originally appeared on Wealthy Nickel and has been republished with permission.

How To Buy A Home With Bad Credit

How To Buy A Home With Bad Credit

Is it easy to buy a home with bad credit? No, but it’s not impossible to do so. Before engaging in a search for a home, you should find and review your latest credit report and credit score. There is quite a financial difference in the thousands between paying a monthly loan based on a bad credit score and an excellent one.

You want to know where you stand as a potential creditworthy borrower. There may be errors on your credit report that you can be easily correct.

By itself, it is overwhelming to buy a house. The home buying process can be intense and emotional between buyers and sellers, brokers, inspectors, lenders, and attorneys. Having bad credit adds a significant hurdle. Unless you have substantial liquidity and pay cash for the house in full, you will have to rely on a lender who will provide a mortgage.

Can You Buy A House With Bad Credit? Check Your Credit Score

A credit score reflects your creditworthiness based on an analysis of your credit information provided by the three credit bureaus, resulting in your credit report. The FICO scoring system ranging from 300-850 remains the predominant model used by financial institutions. Your creditworthiness increases with the higher the score.

Various people may ask for your credit report and credit score. They are lenders, landlords, employers, cable companies, utility providers or even to obtain a smartphone, a prospective business or life partner. Your creditworthiness reflects your attitude on your finances and paying your bills on time.

What Is Considered A Bad Credit Score?

Generally, there is no stated specific minimum credit score that all lenders will universally accept you and give you a loan. The lower your credit score, the higher the risk for the lenders to view you as a borrower. They may lend you money, but you will be paying a higher monthly loan amount. Others may pass on giving you a loan.

All lenders have different requirements. Once you accept the probability of paying a higher interest rate, recognize that you can improve your credit score and refinance your mortgage later on. It may be challenging, but it will be financially worthwhile to make this one of your priorities.

Some lenders may accept a larger down payment (e.g., 20% or more of the home’s price) to offset a lower credit score. Typically, you will have more borrowing opportunities in the 670 or higher range than below 580, where it will be pretty challenging. You will be able to buy a house with bad credit but be open to options provided by the lenders.

FICO Credit Score Ranges Per Experian:

  • 800-850 Exceptional
  • 740-799 Very Good
  • 670-739 Good
  • 580-669 Fair
  • 300-579 Poor

 

 First, let’s talk about how the FICO Scores formula works using information from your credit report. They use five criteria that are proportionally different in value.

Payment History  (35%)

 Payment history accounts for 35% of your credit score. It carries the most significant weight in your score. This is one area in which you have considerable control. Lenders want to know if you have paid past credit accounts on time. Any late payments will dent your score on this critical factor. You need to exhibit an excellent track record of not missing payments for the length of any credit outstanding.

Those who are new to being approved for their credit cards need to show a consistently positive pattern. 

Amounts Owed  (30%)

Amounts owed reflects on your credit utilization. Lenders do not want you to use a significant amount of your available.

A significant influence on your credit score, credit utilization is the ratio of your total outstanding revolving credit balances divided by full available credit. Revolving credit refers to your credit cards and credit lines you may have but does not include your car loan (unless on your credit card) or your mortgage.

The utilization ratio is known as the balance of debt to available credit or debt-to-credit. It measures how much credit you have used for the amount available to you. You don’t want to “max out” your credit cards.

Having a  30% or higher utilization ratio tells the lender you are using too much credit, impacting your score. I would stay in the mid-20s range so as not to hit the 30% level. To an extent, you have more control over this factor, like payment history. 

 Length of Credit History (15%)

How you handle credit is essential to lenders. The length of time of your oldest credit account and the average age of all of your accounts determine your credit history. When you are just getting your credit card and borrowing, your credit history is short and out of control. The older the account, the better your credit score. If you are new to obtaining credit, it will take time to benefit from showing up in your score.

Don’t Close Any Accounts

You should not do some things, such as closing an account because of not using them actively. Closing a credit card can negatively impact your score in two ways. First, the longer your credit history, the better, so you don’t want to close an older card. At the same time, you will take away the available credit on that card, raising your overall credit utilization rate. Rather than closing your account, leave the card in a drawer where it will do little damage.

 Credit Mix  (10%)

Lenders favor some variety of borrowing in your mix of credit. A borrower handling different kinds of debt products may reflect less risk to lenders. When you don’t yet have a credit card, you may be at higher risk. Don’t go out and apply to get different kinds of loans for the sake of improving your mix. 

New Credit (10%)

When you apply for new credit, a creditor will review your credit file to assess how much risk you pose as a borrower. As such, it results in a “hard” inquiry on your credit report for up to two years. Hard inquiries can negatively impact your credit score, particularly if you are making multiple inquiries. However, don’t let it stop you from doing comparison shopping for the same type of loan.

A soft inquiry occurs when you are checking your credit score or report. Soft inquiries do not generate negative hits. Avoid getting new credit simply because you lack credit history. Over time, you should apply for what you need. 

 How Much Of A Difference Does A Credit Score Make On Your Loan?

According to the following credit scores, using myFICO Loan Savings Calculator,  here are national 30 year fixed mortgage rates with a $300,000 loan on May 26, 2021. The higher the score, the lower the monthly payment. The difference between $1,204 and $1,469 may not seem that vast for one month. However, over 30 years, these costs have become significant. 

      Scores              APR                  Monthly Payment

  • 760-850    2.624%                 $1,204
  • 700-759    2.846%                 $1,240
  • 680-699    3.023%                 $1,269
  • 660-679    3.237%                 $1,303
  • 640-659    3.667%                 $1,375
  • 620-639    4.213%                 $1,469

 

Besides your credit score, lenders will consider your debt-to-income, loan-to-value ratios, and cash reserves as indicators of your overall financial health. They are looking for clues to inform them how comfortable you are with paying down your debt. 

Debt-to-Income Ratio

The debt-to-income ratio or DTI compares how much you owe each month relative to your monthly earnings. Specifically, it’s a percentage of your gross monthly income before taxes that covers your monthly bills, including monthly rent or mortgage, student loans, car payments, credit card payments. Divide the total amounts by your gross monthly income. The lower the DTI, the less risky you are to lenders. Most lenders would prefer a DTI below 36%, with a DTI of 20% is considered excellent.

Loan-To-Value

The loan-to-value (LTV) ratio is typical ratio lenders use to express that amount of borrowing to the appraised value of the asset purchased, such as a home.

High LTV ratios indicate that the borrower is putting a lower down payment on the home they are buying. The calculation is straightforward: divide the loan amount by the asset’s appraised value, which secures the loan as collateral to the lender. A typical LTV is 80%, meaning you are putting 20% down on your home. It means that you own 20% equity in your home. If you can put down more than 20%, that will give a lower LTV than 80%, which is excellent. It is not unheard of for people with excellent credit to have a 50% LTV.

The higher the down payment towards the purchase, the less risky the loan as the borrower puts “more skin in the game” since they own more of the property. If you have poor credit, you can target a higher down payment, which can help you get approved for a loan.

A borrower putting too low a down payment may need to buy mortgage insurance to cover the lender against potential loss if the borrower can’t pay the loan. Federal loans may not require a substantial down payment.

Cash Reserves

Having readily available cash reserves that can cover six months of your basic living needs when you face emergencies is essential. Bankers want to see you have the ability to pay for six months of mortgage payments and prefer you to have some cash reserves on hand.

Homebuyers can apply for a conventional loan from private lenders or government loans, depending on their circumstances regarding their credit scores, ability to put a down payment, and other criteria.

 Conventional Loans

It may be challenging to qualify for a conventional mortgage if your credit score is below 640. Lenders may require a higher down payment of at least 20% to offset your lower score. Most private lenders will require private mortgage insurance (PMI) when borrowers put less than 20% down on their home loans.

You should continually improve your credit score to get a better interest rate for your loan. It takes time and patience but raising your credit score is possible. If a conventional loan is out of the question, you can either work on improving your score or apply for a government-backed loan. 

Government Loans

For those borrowers with bad credit, you can apply for federal government-backed loans. You may have more flexibility on the credit score and require a lower (or even a zero) down payment. However, each entity may require its respective mortgage insurance (similar to PMI) when down payments are less than 20% of the home value.

Federal Housing Administration or FHA Loans

An FHA loan is one of the more lenient options for buyers with bad credit, may have gone through bankruptcy, foreclosure, or first-time homebuyers who may not have saved a large enough down payment.  Created in 1934, the FHA guidelines for borrowers are:

  • A FICO credit score of at least 580  requires a 3.5% down payment.
  • If your credit score is between 500 and 579, you need a 10% down payment.
  • Borrowers will need to buy a mortgage insurance premium (MIP) if down payments are below 20%.
  • The debt-to-income ratio must be less than 43%.
  • The home has to be the borrower’s primary residence.
  • The borrower must show steady income and proof of employment.

All FHA loans require borrowers to buy a mortgage insurance premium (MIP). This insurance protects lenders from losing money should the borrower default on the loan. Mortgage insurance requires an upfront fee of 1.75% of the original loan amount. There is a recurring monthly fee varying from 0.45% to 1.05% of the loan amount. The fee percentage depends on the size of the loan, down payment, and the number of years financing.

An  Example On The Mortgage Insurance Fee

Let’s say you are buying a $200,000 home, with a 10% down payment of $20,000. Your original loan is $180,000. The upfront mortgage insurance fee of 1.75% x $180,000 is $3,150. You will also have a recurring payment, using the fee of 0.45% to 1.05% of $810 to $1,890 in the first year.

Veteran’s Administration (VA) Loans

VA home loans are non-conventional loans available to veterans, those serving in the military, or eligible surviving spouses seeking to become homeowners. Private lenders are the issuers of the loans, but the VA determines who qualifies for the loans and is the guarantor.

If you are qualified for a loan, there is no minimum credit score, and you may buy a home with no down payment. Although you don’t pay private mortgage insurance, there is an upfront VA loan funding fee of 1.4% to 3.6% of the loan amount if you put less than 5% down payment on your home.

USDA Loans

The USDA loans are for rural borrowers who may qualify for a mortgage directly from the US Department of Agriculture or a USDA-approved lender. The loan has specific home requirements, and its location must be in a qualified rural area.

You may not need a minimum credit score if you are getting the loan directly from the USDA. However, to qualify for such a loan when using a USDA-approved lender, you will need to have a minimum credit score of 640.

You don’t need to put any down payment for the USDA loan. However, like private mortgage insurance for conventional mortgages or MIP for FHA loans, borrowers of USDA loans pay mortgage insurance via two fees. There is an upfront guarantee fee equal to 1% of the loan amount and a recurring fee of 0.35% of the loan.

Home Loans From Fannie Mae And Freddie Mac

Fannie Mae and Freddie Mac were government-sponsored entities, transitioning out of conservatorship. Neither entity originates or services its loans but buys loans from private lenders who require PMI if down payments are less than 20%. Their respective loans are designed for low income first-time or repeat homebuyers with limited cash for down payments:

Fannie Mae HomeReady Mortgage requires a 3% down payment with a 620 minimum credit score. They may use alternative data with a lower score. Borrowers will need private mortgage insurance when putting less than 20% down.

Freddie Mac Home Possible loan requires  3% down with a minimum of a 660 credit score. Without that score, borrowers require a 5% down payment.

Final Thoughts

Buying a home with bad credit is possible. Before searching to buy a home, you should understand your credit report and score. Consider improving your creditworthiness so you may get a favorable interest rate. If you are still getting your own home, there are several government-backed options for qualifying for a home loan if you have bad credit. You can buy a home with bad credit, but you need to take more steps.

You will likely be paying higher interest rates than those who have good-to-excellent credit scores. You will have to pay some kind of mortgage insurance if you cannot put a down payment of 20%. As you improve your credit, consider refinancing your loan.

Thank you for reading! If you found this article of value, please visit us on The Cents of Money and consider subscribing to receive other articles and our free newsletter.

This article originally appeared on Partners In Fire and has been republished with permission.