Financial Literacy 2007 - Mortgages
Option ARM blues

Phil and Stacey try to minimize expenses by shopping around, hunting for bargains and seizing opportunities to cut costs. They consolidated Phil's undergraduate student loans at a very attractive interest rate using a program that calls for gradual payment increases over time. One credit card balance has a zero-percent promotional offer scheduled to end in March.

Although Phil has seen a significant increase in income in the past two years, and is hopeful of another income spike once he graduates in August, raising a family in Southern California isn't cheap. The same is true in South Florida, where they used to live.

Their two boys are both in braces, resulting in orthodontia bills of $350 per month. There is light at the end of the tunnel however, as one son completes treatment this month and the other in August. Their daughter is expected to get braces in 2008.

Playing the game of 'catch-up'

They have no savings accumulated for emergencies, unplanned expenses, an annual trip to Florida or even the coming summer months when they drop down to one paycheck.

Retirement planning has been another casualty of their high cost of living and tight household budget. Their lone retirement investment is a variable annuity for $6,500. Neither has an IRA and neither contributes to a 403(b) plan through work. Phil doesn't know if there is an employer match that they are missing out on by not participating. They readily admit they haven't planned for retirement because, as Stacey puts it, "We've constantly been playing catch-up."

Fortunately they are employed in the public sector, where pensions are still commonplace, provided you put in the time. Due to their job changes when they relocated cross-country, they are starting over from a pension standpoint. Phil's 14 years teaching in Florida will provide only a minimal pension in retirement.

The burden of future college tuition for their three children has been eased to an extent by one of the grandparents purchasing the Florida prepaid tuition plan for each child. One thing Phil and Stacey must establish is, now that they've relocated, how much will the Florida prepaid tuition buy if their children attend college in California. If there is a shortfall, will that be shouldered by them, their kids, Grandma or a combination of the three? Establishing the answers to these questions are necessary for Phil and Stacey's long-term financial planning.

Phil and Stacey have very cost effective life insurance policies paid on a pretax basis via payroll deduction through Phil's employer. Stacey's policy is more than sufficient but Phil's is short considering their lack of other assets. They have two additional policies, one on Stacey and one on their oldest son, that are not paid for via payroll deduction and have modest cash values accumulated. But the premium for Stacey's policy is about to go back up.

To add a couple of final points, neither Phil nor Stacey has any disability insurance coverage. They also receive a sizable tax refund each year, and expect the same again this year.

Key issues
  • Monthly mortgage payment and loan balance have increased, while they continue to make only the minimum payment.
  • No liquid savings for emergencies or unplanned expenses.
  • Rely on borrowing to make up the difference between spending and income.
  • Typically pays only the minimum required payment on credit cards.
  • No retirement savings.
  • Insufficient life and disability insurance protection for Phil.

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