Student Loans: Paying Off Private vs. Federal Loans

Financially, I have accidentally done a lot of things right.  I'm not sure that student loans were one of them.  I got out of my bachelor's degree with very few loans (all federal), but went on to pursue my theatrical dreams.  The tuition was higher than what the federal government would loan me the money to finance, so I had to go back to the financial drawing board.  I was dead-set on attending this specialized school, and it's intensive programming wouldn't easily allow for me to work part time on the side.  My parents didn't have the finances to contribute.  Since I had good credit, I was able to qualify for a private student loan.  So, I took the loan, and never looked back.  I wouldn't change the education or training for anything in the world to tell you the truth.  I still use my theatrical education to this day, and the schooling was among the best experiences of my life.  That being said, I was still being fairly naive when I took out that loan.  Regardless, it's mine now, and I need to deal with it!

So, for those of you in the same boat as me and have both private and federal student loans, it is essential you pay the private loans off first.  They are typically variable rate, and do not come with the same deferment options that federal loans allow you. It is a tricky choice to make (paying them off before the federal ones) because on the surface, they look cheaper.  Right now, I am paying 3% interest on the private student loans.  That is a pretty cheap loan, comparatively.  The catch is, that since it is variable, they can raise it on me as much as they want, whenever they want.  I mean, they have to give me notice, but they can still increase it on me!  Secondarily, they have very limited deferment options, if any at all.  My private loans can be deferred for 12 months over the ENTIRE life of the loan.  That pretty much buys me one year of hardship, or unexpected life event of ANY KIND.  The federal government is much more generous and offers a plethora of deferment choices to keep you out of trouble if something terrible happens and you cannot pay your loans.  For example, you can defer for up to 36 months for financial hardship, or unemployment (among other reasons), and then set your payment plan to adjust based on your income.  While, you don't really want to stall paying them, because the interest will keep adding up, if you have a total and complete life disaster, you won't go into default (which would destroy your credit).

So, the moral of the story is that if you have private loans, they come first.  Please tune in for a explanation of your repayment options for federal student loans.

Retirement Investing and Fees: What are "loads" and "expense ratios"?

I don't know about you, but I've been wanting to deal with investing my money for some time (both creating new investments and tending to old ones), and admittedly, I have been dragging my feet a bit because there are a few things I've felt I didn't completely understand.  One thing is fees and expenses that come with buying stocks, mutual funds, etc.  Your money can quickly get eaten up by fees.

I've been doing my research for several months now because I feel the need to take a more active role in my investments.  Right now, I have a Roth IRA that is invested in the stock market (mutual funds), and a 401K from a previous employer.  I should probably roll the 401k over and would like to move the Roth IRA into a different investment.

9 years ago, my father passed on, and left me a small amount of money.  I immediately made an appointment with an investment consultant at my financial institution and put the the money in a Roth IRA, in an investment that they recommended (a mutual fund).  My money has doubled, so I can't complain there, but I'm not sure this is the BEST choice for me.  You see, the investment I was placed in was an "A fund."  While this isn't the end of the world, it isn't great.  In order to explain more clearly, let me tell you what I've learned about fees that come with this type of investing.

Since I am the kind of person that will invest a certain amount per month, I should be going with a no-load mutual fund (lump sum investors should consider EFT's--more on that in the future).  When buying a mutual fund, one type of fee is called a "load."  A "load" is a commission or sales charge.  These are charged either at the time of purchase or at the time you sell.

An "A-fund" charges a load at the time you purchase the fund.  So, if the load is 5%, and you invest $1000, only $950 actually gets invested.  You've basically lost $50 before you've even started.

A "B-fund" charges a load at the time you sell the fund if you sell within a certain period of time.  Frequently, they will charge you the load at different rates if you leave within a certain number of years.  Maybe it's 5% if you leave the first year, 4% if it's the second, etc.  They also have higher expense ratios (another type of fee), so I would say "B-funds" are the worst choice.  Just avoid them.  Go for what is called a "no-load" and avoid this issue.

You will not, however, be able to avoid the "expense ratio."  An expense ratio is the annual fee you pay for an EFT or Mutual Fund.  It covers administrative and management costs.  Everyone pays it.  You can't get out of it.  So, ideally you want this to be as low as possible.  It will be expressed as a percentage typically.

I just used a Fund Analyzer that helps you to compare funds.  A side by side comparison shows that the fund I am in has an expense ratio of 1.18%.  I chose a no-load mutual fund (an index fund) as a comparison, and see that it has a .15%.  It also showed me how much money this would mean over time.  This make my decision making process really clear!  Even if you are not ready to pull the trigger yet, please log into this Fund Analyzer and play with it, just so you can practice reading it.  Compare your 401K funds or IRA funds, just for practice.  It's made my decision pretty clear!

Grocery Spending: The 50% Challenge

Full disclosure, November always makes me feel a little insecure about my money.  Between November 1st and December 31st, our household of two encounters, Thanksgiving, Christmas, and two birthdays.  It can feel a little overwhelming.

One thing that overwhelms me is our grocery bill.  We have all of the regular breakfast, lunch, and dinner meals to account for PLUS the things we are obligated to bring with us for holiday meal gatherings we attend.  This is why the weeks preceding Thanksgiving are so important.

At our house, we go to the grocery store once per week typically.  On average, it is a hundred dollar trip.  This week, I issued myself a 50% challenge.  If I could achieve this kind of savings, I could reallocate that same money to some of the holiday extras!  That being said, could I really buy our groceries for the week for HALF of our normal spending?  If I was going to try, I would need a serious game plan!  I am one of those people that seriously likes rules.  The "do" and "don't" categories work for me, so I created some guidelines to help myself out, and if you decide to take the 50% challenge, I encourage you to follow them as well!

The 50% Challenge

Guidelines:

1. Analyze your assets!  You probably have tons of things that you can use to your advantage in your pantry, freezer, or refrigerator.  Go rummage through them.  You will build your week around the things you already have working in your favor.  It turned out that my assets included tons of grains, beans, canned tomato products, and pasta (frozen and dried).
2. Decide how many different meals you need.  They key word here is different.  Our breakfasts and lunches are identical 5 days a week.  What about dinner?  As a time saver, we cook 2 big meals on the weekend, and reheat them for dinners during busy week nights.  So, for my household, that's 4.  We need 4 different meals!
3. Decide WHAT those meals are going to be based on your assets.  My breakfasts and lunches will be the same that they have been, and dinners will be some version of burritos or rice bowls and pasta.
4. Make a grocery list.  Only write down realistically what you need to fill in the gaps.  The point in the list is to avoid impulse buys.
5. Buy only what is on the list!
6. Be willing to compromise on brands in order to get sale prices.
7. Buy in bulk.  It's cheaper than prepackaged most of the time.

I admit that I was doing a little mental math as I walked through the store, but I was still unsure of the total since I had some bulk items in my basket.  I got everything on my list for $48.06.  My goal was $50, which effectively slashed our grocery store bill in half!

Mission Accomplished!

The Landlord Files: How do I know if this house will get a good return?

Landlording can be a very financially rewarding endeavor, but it can also suck the money and life right out of you.  How can you tell the difference before you buy an investment property?  If you already own a property that is not being used as a rental, would it make a good rental?  Here is how you can tell.

Calculate Income and "Cap Rate"
1.  Determine how much rent this property can earn in a year.

If it's rented already, you have that number.  Otherwise, research local rental values for similar homes to come up with an estimate.

2.  Determine the annual expenses created by this property.  This includes:

• projected vacancy rate (5-10% of annual rent is typical)
• utilities paid by you (water?  garbage?  Some localities require landlords to pay certain ones.)
• repairs (new roof, new furnace, siding repair, emergency plummer?  These things will come up.  1-3% of the home's value is a good estimate.  I use 3% since I bought a foreclosure, and assume those numbers higher.  If your home is newer, you may use a lower percentage.)
• property taxes
• insurance
• management fees (if you use a rental management company)

3.  Calculate "Annual Net Income"

• Annual Rent minus Annual Expenses
• Mine is:  17400-9800= 7600 (roughly)

4.  Calculate the "Cap" Rate

The capitalization rate is the expected annual rate of return.

• Divide net income by cost of property.
• Mine is:  7600/102500= 7.5% (approximately)

If you took out a mortgage on this home (or plan to), you still do NOT place that number in this calculation.  Once you have this calculation figured, do some number crunching to see if there is still a healthy enough return to account for your mortgage payment AND a few worst case scenarios.  One year you might have more vacancies or late rent payments than usual.  The year you replace a roof or something huge may look a little different.  You may have a series of expenses come up in the same year.   If you don't leave a significant cushion, you could quickly operate at a loss.

Personally, I won't invest in a rental property with less than a 5% cap rate, but that's just me!

Budget Revisited: Avoiding the Trap of Two Incomes

Those of you who have read last week's blog post have probably been thinking about your own monthly spending habits, and the possibility of shoring them up.  For those of you who missed it, the concept is 50/30/20.  The jist of it is that you should budget your money so that your fixed expense necessities take up no more than 50% of your monthly budget (housing, transportation, heat/electric, or anything that cannot be trimmed or deleted), 30% for flexible, lifestyle expenses (these items maybe important, but could be trimmed or have payments altered if needed; think: minimum credit card or student loan payments, cable, cell phone, groceries, dining out, entertainment), and 20% for goals (paying down debt and saving for your future).

I want to revisit the 50/30/20 idea for a moment.  Hopefully this doesn't throw a wrench into your budgetary plans.  What number are you calculating your percentages based upon?  We have two incomes in my household for the first time in years.  My partner went back to school a number of years ago, and we lived off my income during that time.  Now that we are both working our income has literally doubled, but I didn't update our budget.  "BAD!  Bad personal finance writer!"  It's okay, I know you were thinking that.  Let me explain.  This move is totally on purpose.

I'm tempted to offer you a catchy anecdote that explains to you exactly WHY you should create a budget based on one incomes, but I think we should just let the numbers speak for themselves.

Let's say I take home $3000 per month after taxes.  According to the 50/30/20 guidelines, I have:

• 50% Fixed-Cost Necessities:  $1500
• 30%  Flexible Lifestyle Expenses:  $900
• 20% Goals:  $600

Those numbers look familiar, right?  We used them last week.  Now, let's say we have two incomes of $3000 per month after taxes.  That makes $6000 per month incoming.  If we apply our formula (50/30/20) to it, it looks like this.

• 50% Fixed-Cost Necessities:  $3000
• 30%  Flexible Lifestyle Expenses:  $1800
• 20%  Goals:  $1200

I know what you're thinking "WOOHOO!  THAT'S the lifestyle I'd really like!"

Hold it right there.  Not so fast.  Let's have some fun with numbers for a second.  What if you had both of those incomes, and budgeted to ONE of them, placing the remainder of the money into "Goals"?  It would look like this:

• 50% Fixed-Cost Necessities:  $1500
• 30%  Flexible Lifestyle Expenses:  $900
• 20%  Goals:  $3600

In one year's time, that goals category would amount to $43,200!  Can you imagine what you could do with an extra $43,200?  I sure can!  While I know these were made up numbers, and your situation is different, I just want you to let this sink in for a moment.  This is house down-payments, student loan payoffs, a fully funded emergency savings; the possibilities are nearly endless.

If you are single, you likely won't be forever.  Maybe you should consider THIS strategy when you start to become serious with that special someone.  If you are in a couple, can you squeak by on one income?  In my household, we have done so for years.  It was purely circumstantial, but one of the smartest moves we've ever accidentally made.  Since I've always been the bread-winner, we will continue to budget to my income, and add my partner's income directly into the "Goals" category.  One year from now, we will have more than $10,000 in debt paid off, have 2-3 months of our emergency fund funded, and paid for a new roof on our rental property in cash.  That feels amazing to me.

If you are in a couple that has already bought a house, and you budgeted to two incomes, maybe you can't live off one.  Review your budget.  Could you live off 1.5 incomes?  Try it for a 2-3 months.  You might surprise yourself.

If you are in a couple, and rent.  I want you to seriously consider buying a home (assuming you have that as a goal) that could be paid for on one income even with other bills.  If you are single,  you have not yet combined finances with another person.  when that comes down the pipeline for you, don't you dare budget to both incomes.  Regardless of your goals, you will meet them much more quickly if you avoid the trap of two incomes!

Note:  I started using this phrasing "two income trap" years ago.  I didn't even realize that the fabulous Elizabeth Warren has written a book using this same title.  I have not read it, but have added it to my list.  I just wanted to point this out for a couple of reasons.  1.  Some of you might want to read it.  2.  This post is in NO way meant to relate to that book in any way.  I am sure it is fabulous, and I would like to read it, but my thoughts and ideas are not intended to relate to it in particular.

Creating a Budget: The 50/30/20 Budget System

50/30/20 Budgeting

                Now that you have an idea where your money is going, we can zoom in on this a little.  I want to introduce you to the 50/30/20 Budgeting Guideline (initially made popular by Elizabeth Warren).  If you type it into a search engine, you will get a zillion hits.  It is basically a guideline that helps you to determine how much of your income should be going where.  Different financial writers will describe them slightly differently, but here is my version:  50% of your take-home pay should go to fixed expenses, 30% goes to flexible (or lifestyle) expenses, and %20 should go toward goals.

50% Fixed Expenses

               

Let’s look at the first category.  This is the 50% category, and it is devoted to fixed expenses that are needs only.  There should not be any wants in this category.  These are the things that you literally must have to function, and they cost you the exact same thing every month.  Your rent/mortgage payment, the cost of your transportation to and from work, certain utilities, etc.  I put  only a handful of things in this category because there are very few things that are fixed cost needs.  Quite frankly, I even put groceries in another category, because while I need food, I can scale back on certain items to impact the dollar amount I spend.  I do not have that kind of choice where my mortgage, rent, car insurance, car payment, or public transit pass are concerned.  Those items cost me the same thing every month, I can do literally nothing (short of moving, selling a car, etc.) to alter the cost, and I absolutely must have this in order to function in my day to day life.  Once you have figured out which of your subcategories (mortgage/rent, car insurance, etc.) go into the 50% Fixed Expense category, you need to do a little math.  If you take home $3000 each month after taxes, then this category should take up no more than $1500 per month.   If you are spending more than 50% of your take-home income in this category, you may need to face some tough choices in order to get these numbers down.  You may need less expensive transportation or housing.  Alternately, you could consider a roommate or an extra job.  You maybe wondering why it matters whether or not you go above 50%, especially when these expenses are the most fundamental to your life.    It’s a fair question.  If you are spending so much money in this category that it goes above 50%, you won’t be able to pay down your debts or save for your future.  If you are unable to do those things, you will risk putting yourself in an unstable position when you are in your golden years.  If you are struggling to make ends meet now, when you are theoretically in the best health and with the most energy to work, how do you think you will get along when you are significantly older?

30% Flexible or Lifestyle Expenses

                The next category is for Flexible or Lifestyle Expenses.  This should be no more than 30% of your after-tax monthly pay.  These could be one of two things:  a regular monthly bill that could be trimmed back if you needed to or has a changing payment amount, or things that you spend money on for recreation of some sort.  There are a few things that are in this category that appear to be REALLY important, so important in fact that you may wonder why they weren’t in your 50% category.  Let’s take a look at a few.  The first item is groceries.  You MUST have food to live, but this expense is flexible.  If you fall on hard times, you may qualify for the food stamp program which will alleviate you of some of these expenses.  You also have a huge range of choices regarding what to buy and how much it will cost you.  Perhaps dining out is a huge priority with regards to lifestyle.  That number also shows up in this category.  Another surprising item that is in this category is your cell phone bill.  You need telephone access now days, but let’s be honest.  You probably do not have the cheapest most basic plan available right?  Well neither do I, and that’s fine.  It is a lifestyle choice, and if push came to shove, and you could scale back that expense as needed.  Another expense that is very important, but flexible is your student loan debt.  It is very important that you pay on these debts, but the payments are flexible.  If you became ill or unemployed and your student loans are federal, you can have your payments reduced or deferred.  A credit card payment is also a flexible expense.  As your balance goes  up or down, your payment amount will change.  If you became ill or unemployed, these debts could be discharged in a bankruptcy (not ideal, but possible).  Other items that are flexible, lifestyle expenses are entertainment, dining out, clothing, and many others.  The basic rule of thumb is that if you could reduce the payment or eliminate some or all of the expense, then it is in this category.  Note about student loans and credit cards.  Only the minimum payment amount belongs in this category.  Once you have determined how much money you are spending in this category, compare it to 30% of your take-home income.  If you are spending too much in this category, you can easily fix it.  Decide where you can scale back so that you are comfortable within that limit.  If you are already below 30% in that category, even better.  You have more funds to allot to goals.

20% Goals

                That brings us to the final 20%.  This is for goals.  This is the category that makes me feel excited because I feel like this category is directly related to my own financial freedom and future.  If you earn $3000 per month after taxes are taken out, then 20% is $600.  That is the amount you can spend on goals.  Goals should be a combination of savings and paying down your debt.  These are both super important, and you should be doing both.  If you have money left over from another category, I recommend that you give it a home in the “goals” category.   Paying down your debt will free up some of your income for other things.  In terms of savings, you should have at least two different types:  retirement savings and emergency savings.

If you are using some kind of software to help you with this budgeting, it will easily figure these numbers for you.  If you are using pen and paper, just calculate how much is 20%, 30%, and 50% of your income, and track it.  Each month you will be able to see whether you are within the parameters you have set for yourself and adjust your spending as needed so that you can make progress toward your goals.

Financial Freedom: Finding a Starting Point

Financial Freedom:  Finding a Starting Point

Being poor as a child taught me the value of hard work and determination.  I am not sure what having money teaches a child.  I imagine that it gives them the freedom to just be a child.  Hard work and determination were not gifts bestowed upon me.  The fact is that I earned them both.  That being said, I will also have to earn my freedom.

When people say that they want to be rich, I am not sure if that is what they really mean.  I suspect, they really mean that they want to be free.  Don’t we all want that?   It’s the freedom to do what we love regardless of what it pays.  It’s also the freedom to have control over our own time.  It’s also about opportunities.  Have you ever missed out on opportunities because you couldn’t afford them?  I have, and enough is enough. 

But where do I begin?  If my finances are a journey, and I am plotting along on a road to financial freedom, it seems vital to know where I am starting from. 

Step 1:  Track your expenses

Most of us don’t actually know what we are spending or what we are spending it on.  Spend at least 1 month doing this.  I spent several months on this activity.  In this first month, try to spend as you would normally.  Not more, not less.  The point in this activity is to find out where you are starting from.  Honesty is key.  Collect every receipt.  If you don’t get a receipt for something, keep a pad of sticky notes or something with you and immediately jot down the dollar number and what it is that you purchased.  Then stash the receipts somewhere.  I use a cigar box.  At the end of the month, make a date with yourself.  Pour yourself a glass of wine (you’ll need it), and dig in.

Sort the receipts into piles of “like purchases.”  You can take a little creative liberty here in choosing your categories.  Remember this is just a rough sort.  Now, very quickly pick up each pile and leaf through it.  Does everything you see truly belong in the same category?  My realization was that my “food” category really needed to be three categories, so it became “food”, “date night,” and “liquor”.  Now, don’t judge yourself, just be honest.  If you find that you have seven receipts for coffee, maybe you ought ask yourself “Is that a major category for me?”  Or at the very least, is it deserving of its own pile? 

Once you are happy with your categories, either grab a notebook that is designated for this purpose only, or open a spreadsheet (for those technological types).  Start writing down all of your spending categories.  This is a combination of the categories you created when you sorted your receipts, and your monthly bills.  Next to these categories, make a column for your estimated spending.  Now, do NOT calculate anything yet.  Just write down how much money you THINK you are spending in any given category per month.  After you are done, gather all of your monthly bills, and you get to start totaling.   Next to your estimated total, you will enter your actual spending amount for the month.  Then total both columns and compare them to your after-tax income.  Did you think you had a surplus?  Deficit?  What was the reality?  Do you have a surplus at the end of the month or are you in the red?  This is where the wine comes in.  Stop judging yourself and study your numbers.  Are you uncomfortable with what you see?  I was, but that’s okay.  All great journeys start with a roadmap, but a roadmap is no good to us if we don’t know where we are starting from.  Where our finances are concerned, the roadmap is our budget.  Now, of you might be thinking “Lacy, didn’t we just create a budget?”  The short answer is “no.”  We did not create a budget, we found our starting point.  We are being honest with ourselves, and have begun our journey.  We will look at budgets next.

What interesting thing did you learn when you tried doing this activity for yourself?