Be savvy with taxes to create retirement account. While they're at it, they should sign up for retirement plans at work. How are they going to pay for this? By adjusting their tax withholding so their net pay is unaffected. It makes no sense to wait all year for that sizable tax refund while they're borrowing at every turn. On the retirement plans, it may make sense to contribute only to Phil's right now if that enables them to max out any employer match. Don't leave any free money on the table! They must establish the habit of saving pronto.
Continue making the minimum payment on the HELOC for now. I'd like to see Phil and Stacey eliminate the debt on the two credit cards and demonstrate an ability to live within their means – which means adding to savings while paying down debt – before taking on more home improvement expenses. The only debt they should add in the next year is for Phil's remaining tuition payments, which should be done via lower-rate student loans rather than credit cards.
The family has two life insurance policies that it pays to terminate, one on Stacey and one on their oldest son. Both of these policies have accumulated a cash value, but neither of these policies is necessary. For each, find out the surrender charge before terminating, but the remaining cash value can be used to boost savings and pay down debt. The monthly savings could be used to add an additional 10-year term policy of $150,000 on Phil since he is the family's primary breadwinner, or investigating disability coverage, which they currently do not have. As with Phil's existing policies, these should be paid for via payroll deduction.
Future looks brightOnce Phil graduates and secures a promotion, they can further accelerate the repayment of credit card debt, boost their retirement contributions further and dip their toes back into the home-improvement waters. But the key will be paying those renovation expenses out-of-pocket, rather than stacking it on the home equity line.
Other winds of fortune will blow their way in the next year. Orthodontist payments for the oldest son will stop in August, giving them a six-month reprieve before their daughter starts treatment. Also, Phil's car will be paid off in another year, freeing up additional room in the monthly budget. Using those months to increase their savings cushion is vital in the event they incur any car repair bills or to make a down payment when they next decide to purchase a car.
The next 12 months could be very big for Phil and Stacey in terms of making financial headway, but it won't be easy. It will mean some tough decisions on spending, and I know Phil won't want to let the home remodeling project sit idle. The toughest part will be getting started. But if they focus, they will make significant progress. I look forward to revisiting their situation later this year. Good luck!
The plan in 6 steps
|1) Get on a budget.|
Tools: Use this work sheet to create a budget.
- Track every dollar that comes in and goes out.
- Cut miscellaneous spending to a maximum of $500 per month.
|2) Establish a savings cushion.|
Tip: Find high-yield savings account.
- Postpone completion of the home remodeling.
- Open high-yield savings account.
- Put the extra money from paid-off orthodontist bill and credit card in this savings account each month.
|3) Refinance into a 30-year fixed rate mortgage.|
Tip: Find best fixed rate mortgages in your area.
- Check current mortgage for prepayment penalty.
- Better define spending through a written budget to make room for a mortgage payment.
- The payment on fixed rate mortgage will be larger, so shop carefully for best rate.
|4) Start saving for retirement.|
Tools: This retirement calculator will motivate you.
- Stacey and Phil sign up for employers' retirement savings plans.
- Money for the contributions will come by reducing their tax withholding. (This enables them to save for retirement today rather than waiting on an oversized tax refund next year.)
|5) Eliminate all credit card debt.|
Tools: What will it take to pay off my credit card?
- Use all of the tax refund to pay off the credit card with the expiring promotional rate.
- Stop buying on credit. Put credit cards away.
- Put extra money from paid-off orthodontist bill and other reduced spending against remaining card balance.
- Use savings from reduced spending toward credit card balances.
- Take out a student loan for Phil's remaining tuition rather than charging on credit cards.
|6) Change up life insurance policies.|
Tools: How much life insurance do you need?
- Cash out the unnecessary life insurance policies.
- Use the remaining cash value to boost savings and pay down debt.
- Add 10-year term life insurance policy on Phil.
This report was prepared by Bankrate Senior Financial Analyst, Greg McBride, CFA.
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