Financial Literacy 2007 - Mortgages
Escaping from an option ARM

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 bright

Once 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.
  • Track every dollar that comes in and goes out.
  • Cut miscellaneous spending to a maximum of $500 per month.
Tools: Use this work sheet to create a budget.
2) Establish a savings cushion.
  • 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.
Tip: Find high-yield savings account.
3) Refinance into a 30-year fixed rate mortgage.
  • 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.
Tip: Find best fixed rate mortgages in your area.
4) Start saving for retirement.
  • 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.)
Tools: This retirement calculator will motivate you.
5) Eliminate all credit card debt.
  • 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.
Tools: What will it take to pay off my credit card?
6) Change up life insurance policies.
  • 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.
Tools: How much life insurance do you need?

This report was prepared by Bankrate Senior Financial Analyst, Greg McBride, CFA.
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