Making any budget work means
playing your credit cards right
First of a five-part series:
Add it up: Budget ideas that work for you now
By Lucy Lazarony • Bankrate.com

Regardless of age or income, many Americans smooth out the kinks in their budgets by flashing the plastic.

Many Gen Xers use plastic to stretch entry-level salaries to cover the costs of setting themselves up in life -- and to play. Thirtysomething couples with growing families and thick mortgage payments reach for credit cards to help meet burgeoning expenses.

And costs only escalate as people enter their 40s and 50s. There's college tuition for the kids and medical expenses and housing for retired parents, not to mention the cost of preparing for retirement.

"Credit used well is a wonderful thing. Credit used poorly is tragic," says Mari Adam, a financial planner in Fort Lauderdale, Fla.

The best way to keep credit working for you, instead of against you, is to track spending and to know where you are in terms of cash flow. Someone who makes less money than they spend on necessities has a basic problem that needs to be resolved by cutting expenses or increasing income. Credit is never affordable unless basic needs are being met with cash.

Often, people get into trouble because they're simply not paying attention.

"They have absolutely no understanding of their own financial situation," said Tahira K. Hira, the founder of the Family Financial Counseling Clinic at Iowa State University. "They don't understand cash-flow management. They don't understand what they earn and what they bring home and what that income level can buy them."

DON'T HAVE A BUDGET? DIG OUT your checkbook, credit card receipts and other paperwork (you know, you had it all for December's special report) and take a few minutes to work out your numbers. IT MAY BE a depressing reality, but write down a budget based on what you're spending now, even if you don't really want to see it on your screen. THEN WORK THROUGH the segments of this special report and see where and how to make changes. When you're done, you'll have a new budget for the new year.

So the first step is to figure it out. Once the basic needs are met the rest of the money is disposable income. It can be socked away for future needs or it can be spent on designer clothes, sporty cars, fine dining, trips to Paris and impressive gifts.

Most people do some of their discretionary spending with credit cards.

How individuals spend the extra cash from each paycheck depends on their priorities in life. The importance of setting priorities and the willingness to give up some of one thing to have more of something else cannot be overstated. Experts point out that trying to have too much of everything is a common financial misstep.

How much is too much debt? People are in danger if total debt payments, including mortgage, auto loans and credit cards, account for 46 percent of net income (pay after deductions), according to a 1996 University of Texas survey of financial planners and educators.

Clearly, moving into an expensive, new home might mean driving an older car until income catches up with the expense of replacing the car.

General guidelines from the Consumer Credit Counseling Service say debt payments, excluding auto and home expenses, should not exceed 5 percent of income. Yet the organization suggests an additional 5 percent each for recreation, clothing and miscellaneous expenses, all things that are likely to end up on credit cards.

Starting out doesn't mean starting on a downhill slide

• DANGER ZONE: Those in their first jobs make the least amount of money they ever will (they hope) but face lots of life's startup expenses. Things such as furniture, work wardrobes and new transmissions may need to be put on plastic, but are necessary investments in an adult future. For young, single adults with little disposable income, the temptation to finance fun is strong. Next year's raise shouldn't be paying off dinner and theater tickets from last week's blind date, or the standard of living never will improve.
  
• PAYOFF PLAY: Using credit cards to leverage today's necessities against tomorrow's increased income is OK, as long as debt levels are realistic and the charges really are paid off as new money comes in.

Gen Xers may already have a big chunk of credit card debt left from their college days. Many use credit cards to pad their salaries. Experts say they tend to charge clothes for work and play, their first real furniture, dinners out and travel.

"It just creeps up on them without them realizing how hard it is to pay off that debt -- say $10,000," Adam said.

For many young adults, the first years after school are a period of heavy expenses. First apartments require everything from stereos to kitchen tables and spine-friendly mattresses. Gen-Xers can score a coup by taking advantage of interest-free credit when furniture and department stores offer it. The trick is to have enough disposable income to pay off the items in full before the deadline imposed by the credit plan. Failure means brutal interest rates, often more than 20 percent.

Racking up too much debt at this stage in life creates a financial situation that can take years to resolve and color one's lifestyle for decades. So setting priorities is especially important starting out. Is living alone more important than a new car? Is a trip to the Congo more important than a stain-free couch?

Do you own the house or does the house own you?

• DANGER ZONE: Moving into that first house can be a budget breaker. It's not just that hefty mortgage payment but the upkeep and maintenance of the house. And then of course there's the yard to worry about. And don't forget the cost of furnishings. It's no wonder that so many new homeowners are reaching for the credit cards after pouring all their cash into buying a dream home. Demands become even more pressing if children are introduced to the new household.
  
• PAYOFF PLAY: Don't make yourself "house poor." Tuck some money away for home emergencies before any home-furnishing buying binges on drapes or carpeting. Resist the urge to make your home "perfect" with plastic. Try furnishing one room at a time. Watch for sales, especially those that offer deferred billing (as long as you pay it off). Consider buying used furniture -- for now -- and saving for the Ethan Allen stuff you really want.
  
  Kids create emergencies, too, so make sure your emergency savings takes them into account. Until then, keep some room on your cards. Resist the urge to spoil your kids now with toys -- and later with bad examples of how to handle money.

By the time people start to "settle down," perhaps in their 30s, there's a whole set of new expenses to juggle. The two biggest: the kids and the house.

"These people are probably spending more than they're making -- that's a tough age. There's a lot of pressure on them to consume," Adam said. "It's not as much fun stuff. It's not so much keeping up with the Jones. The kids need things. The kids need diapers."

Needs are no longer simple and they can be unpredictable. Just ask any parent or homeowner.

Money can seem especially tight for people who bought the house of their dreams instead of the house that fits their budget. Most financial planners suggest spending 30 percent to 35 percent of net income on mortgage payments. Again, priorities come in to play, but trouble typically comes if people spend more than that or if they fail to plan for maintenance costs associated with the house.

"I've had clients come here and say, 'We were doing fine until we bought the house,' " said Hal Prather, branch manager of Consumer Credit Counseling Service in Norcross, Ga. One couple could squeeze out their mortgage payment every month but when the house needed shutters, a new roof, when the dishwasher broke -- all that went on credit cards.

However, credit cards can be used to head off surprises, as well as cope with them after they've erupted. Someone who has been able to save a portion of the price of a replacement appliance may be able to save money by putting it on a credit card during a sale. If it can be paid off before the interest reaches the level of the savings from the sale, the buyer is ahead of the game.

But even the most cost-conscious spender may have trouble reining in expenses, when it comes to providing for their children. "The kids have to have the best and all of that goes on the card," Prather said.

And there's a more subtle hazard at this stage: Consumer experts worry about how that type of spending influences not just the parents' bottom line, but the children's future spending habits.

"What they're learning is: If you want it you should get it even if you can't pay for it. That's not a good lesson to teach your children," Adam said. "The best way you can provide for your children is to have sound financial habits and teach them to your children."

So what's more important -- a bigger house or a newer car? Choose. Lots of people can afford one or the other. But not both.

Scaling down for retirement

• DANGER ZONE: Difficult choices come as the kids start to leave home and mom and dad are confronted with meeting college tuition payments as well as saving for retirement. They may also be called on to help grandma and grandpa with housing and medical expenses. Giving to the kids and the folks is fine but be careful not to sabotage your own finances in the process.
  
• PAYOFF PLAY: This is where earlier payoff plays really help. If you didn't make them, scale back expenses as much as possible -- for example, moving into a smaller home now that the nest is empty and, with the kids gone, do you need more than one car? Devote extra cash to paying down credit cards now so that you can eliminate or cut debt payments before retirement cuts your monthly income.

The choices can become more emotionally difficult as people enter their 40s and 50s. Colossal expenses -- college tuition for the kids, nursing home bills for their parents and the need to save for their own retirement -- vie for attention. Here's where good groundwork in earlier in life can pay off.

"There's really no good solution," Adam said. "You do the best you can but you've got to make sure your affairs are in order. The more financially sound you are the more you can help your parents and your children."

Again, priorities count. If there is not enough money, go back over the finances and make decisions that will help reduce the budget. As retirement approaches, this is a time for scaling down.

If the kids are in college, would a smaller home and car do? Would adding a room to your home to accommodate your parents save some of the cost of companion care?

If life is stable, money can be devoted to paying down credit card debt so that it reaches a level that will be affordable on the reduced income of retirement. Pay more than the minimum payment and stick with the payments until the balance is paid off. Then aim to pay off the balances every month.

Experts say it is common for people in their 50s to be nearly weaned from their credit cards, and saving for things they cannot easily afford.

Hira points out that living within your means is a good guideline for every stage of life. "You always have to spend under what you earn to do the things you want in life. Earning is not what makes you rich. What makes you rich is the difference between earning and spending."

-- Posted: Jan. 4, 1999