My history and current situation...where to go next

[annakat]

Back in 2005, my first year after grad school, I was in serious credit card trouble that had been building for a long time, with multiple accounts going to collections and $15,000 in debt. I made a budget for the first time in my life, moved in with my parents when the lease on my apartment ran out, and paid off the credit cards within a year. I still had student loans, and have kept up with them but have not made extra payments to date.

Soon after that, I was fortunate enough to go through a period where I had extra, temporary income - I moved temporarily for work and got a cost of living adjustment on top of my normal salary, and I was able to save a large chunk of it by keeping my expenses down. While I did technically keep to a budget during this time, the budget had plenty of "flex" in it and I spent lots of money on things that I didn't need - but, since I was saving and didn't incur new debt, I just looked at it as enjoying my lifestyle. Looking back, I wish I had saved even more.

Now, I've returned home, had a baby as a single mom by choice, and stepped down my work to 70% of full time (still benefits eligible) in order to spend more time with the baby while she's young. I paid cash for a car last year - a new car. I did negotiate a good price, but the estimated value now is $1500 less than I paid, so I can't convince myself now it was a good decision though I am glad I don't have debt on it! I also bought a house, with 20% down and for $19,000 less than the appraised value. The home was a foreclosure and I did have to put some additional money into it in addition to the 20% down payment. The payment including taxes and insurance, plus $200/month for a maintenance sinking fund, is right at 25% of my income.

All told, I know I'm in pretty good shape, but I guess I'm just still dealing with "sticker shock" of seeing the savings I had built up being depleted for the car and the house. I also have had a hard time adjusting to my decreased income and have had expenses for the house and move, and need to get my spending back under control. And with my daughter's first birthday rolling around, I have this voice in the back of my head saying that I have 18 years to save for college and I've already lost one.

I don't want to increase my work hours. I work in a profession that is very time intensive - if I was working at 100%, the reality is that I'd be working 80+ hour days some weeks (without overtime pay), and I'm simply not willing to sacrifice that time with my daughter. If I were in serious financial trouble of course I would do it, but in my situation I should be able to focus on managing expenses.

I have about $9300 in savings, no credit card debt, $16,200 in student loans, and a $95,500 mortgage balance. I'm currently contributing 6% to the 401(k); my employer matches 25% of that plus 5% regardless of what I do, so if I stop contributions I'm still getting that 5%. If I use all but $1000 of savings, stop the 401k contributions, and the back-of-the-envelope budget I drew up this afternoon proves workable, I could pay off the student loan by the end of the year. I'm not really comfortable pushing the savings that low, though. I can see where "save $1000 then start paying debt" makes sense for someone who has no current savings and desperately needs to start paying debt, but that's not my situation.

I've been trying to decide what level of savings I'm comfortable with, but the desire to get totally out of debt is warring with the comfort provided by the savings and the rebound effect of knowing that my savings was so much higher a year ago and has already been depleted quite a bit. I have a child and a 29 year old house that was behind on maintenance when I bought it (though the major known problems are already taken care of). On the other hand, my job is fairly secure and I have the ability to go back to 100% employment at any time if something were to come up.

In my situation, what level of BEF would you be comfortable with? How aggressive would you be with paying down the student loans (average rate 1.47%)?

[forHISglory]

At that rate on the loans, I suggest to continue to build your savings, especially if you get a higher rate on your investments. Stay current on the loan, and everyone in a while if you get some kind of bonus, then put it to the loan. My best to you!

[Ceashels]

Let me congratulate you on your success so far! What a turn around since grad school.

With a 30 yr old home I would keep enough in my BEF to cover the cost of a furnace or hot water tank replacement at the minimum. How old is the roof on your home and is it in good condition? Big things like that can cost a hefty sum and wipe out a small BEF quickly.

If you took your savings down to 5k and stopped your 401k contributions would you be able to start an education fund for your baby and throw the rest toward the debt? Comfortably?

[annakat]

The hot water tank is brand new, one of the repairs I had to do before moving in, but I get the point of preparing for big ticket items. The roof is in good shape, not sure how old (you lose some of those details when you buy a foreclosure!) but I had a handyman with significant roofing experience tell me he wished he could tell me there was something I needed him to do for me, but there wasn't! I had thought I would need a new air conditioner but was able to let that slide for now, so that's the most likely candidate for a future hit.

If I stopped 401(k) contributions I could double the amount I'm paying on the student loans without significantly altering my budget. So, yes, I could comfortably to start an education fund by managing expenses as well. I would think, though, if I stopped contributions my priority should be to pay off the debt, then start contributions again, and then start the education fund...it seems backwards to start the education fund when I'm not funding retirement, based on Dave's advice and others. On the other hand, putting even a small amount in a 529 plan would probably make me feel better about the whole "1 year down 17 to go!" countdown clock I hear ticking in my head sometimes.

So one possible approach: leave $5,000 in savings, put $1,000 in a 529 plan, put $3,200 toward student loans. Stop contributions to 401(k) and double the amount I'm paying to student loans monthly. Without any other changes, I'd be done with the loans in 21 months - 31 months earlier than if I don't change anything. Depending on how close I get to the budget I drew out earlier, I could shave as much as another 8 months off of the debt. I wouldn't make any additional contributions to the 529 for now, but having that early amount starting to earn some return would help me feel more secure on that front.

[Greebo]

First of all, congratulations on your smart moves thus far! As for the new car - listen - take care of it. Do ALL the recommended maintenance, when its needed - and the car should last you at least 12-15 years or longer unless you're driving more than 12k miles a year. IF you make the car last - it'll make up for the early lost value in the long run. However, there is an alternative I'll bring up in a minute.

Secondly, and you're not going to like what I'm about to say, but, your obligation as a parent is to raise your daughter to be a functioning adult - not hand everything to her on a platter at the cost of ruining your own future

Your daughter, when she's old enough to start learning about money, can learn that money doesn't come from mom, it comes from work. It's a lesson I wish my parent's had taught me...

So at the risk of contradicting my wife (sorry honey) I take strong exception the idea of stopping retirement to fund college for your daughter. I don't, however, think you should keep funding retirement while you're in debt. So yes, for a SHORT TIME (see details of plan below) I would stop retirement all together (except for the free 5% from the boss - nice deal that)

Since you're in the Dave Ramsey forum, lets review the baby steps.

Baby Step 1 is $1,000 in the bank to cover all but the biggest emergencies
Baby Step 2 is the debt snowball - and that's 1 debt, $16,500 - not really that big a deal.
Baby Step 3 is the fully funded emergency fund.
Baby Step 4 is preparing for retirement
Baby Step 5 is preparing for kid's college
Baby Step 6 is paying off the house and finally
Baby Step 7 is build wealth and reach the financial tipping point

Now you're a single mom - you've got a child to think about - I *get* having a big security gland in your case. There are a few things I want to be sure are covered first before we get into your debt which isn't your biggest priority.

1) Do you have term life insurance in the amount of 10x your income in place? If something happens to you - this plus #2 below will provide for your daughter's future.
2) Do you have a trust established in your daughter's name with the life insurance naming that trust as the beneficiary, with a trustee you TRUST to raise your daughter right if you are gone?

If those aren't in place - MOM SHUT UP ABOUT THE DEBT - go tend to darling daughter's future, RIGHT NOW. Then come back.

Ok - so now that baby girl is taken care of in the worst case emergency - lets go back to the daily finances.

You have a little girl and an old house. The old house may be a pain but if the roof, water heater and furnace are in ok shape, a weak AC is dealt with in the short term by window units. (That's what we do - our house was built in 1940 - we suck it up and pay the higher bill cause we don't have the cash to redo the ductwork yet)

Still - as a single mom - I'll take a stab that $9k is probably more than enough to cover your four walls for a few months, is that right? I mean - if all you did was pay the mortgage, bought food, kept the car running and in gas, kept clothed in inexpensive clothes, and kept the lights on, could you live on ... $2k a month? $3k? $1k? If you lost your job, got on unemployment and all the state assistance you could get (WIC, food stamps, etc - everything) without delay - would that $9k last you 3 months? 6?

I would cut your savings down to cover you for 3 months. That isn't the DR way but you aren't a typical DR person - you don't have 2 people to trade off the daughter while the other works. So whatever's left from the $9k after you pare the budget down to skin of your teeth living for 3 months with assistance - that'll go on the student loans.

Next - here's that alternative for your car - sell it. Yeah I know - you just bought it. Yeah, I know it's lost value - tough - you drove it you got the value. Lets say that was a $20k car and it's worth $18,500 now. You spend a few hundred getting it spotless and sell it for $18,000 and you go find a nice used car that runs well and looks ugly for $6,000. NOT a beater - not a car that will need a ton of work - but a car that will get you around for a few years. $18,000 - $6,000 = $12,000 to your student loans. Now the balance is down to $4,500 and maybe less depending on your excess in your BEF.

How long would it take you to pay off less than $5k? Keep in mind you need to budget for life insurance and a bit more $ for car repairs/maintenance but still - faster, right? And of course, you halted your 401k for now.

Ok - so pay off the debt in what, less than a year? Then since you ARE a single mom - bring your EF up to a solid 3 months of expenses - not just 4 walls but you know, a little entertainment, etc. A tight budget but not a desperate one.

Then I would boost retirement fully up to 15% of gross - ON TOP of the match and the bonus 5% - you cannot depend on those always being there.

Yes, 15% and yes BEFORE preparing for DD's college. Listen - think about it as if she were you - one day she's gonna grow up, she's gonna go out, and she's gonna do her own thing. She's gonna be an independent woman like Mom. She's gonna need a good role model. She's gonna need a Mom who 1) didn't spoil her by giving her everything on a platter but made her learn the value of a dollar and 2) a mom who prepared for her own future first!

One day baby girl is gonna go away and live HER life - and you, dear mother, are going to have to take care of YOUR life. Now if you devote all your resources to making sure she has all the money she needs for college and you don't have any retirement, how on earth is baby girl gonna have her OWN life when you're gonna be starving? Baby girl will be spending half her time worrying about YOU when you SHOULD be the role model for her future.

So do NOT put college savings ahead of retirement - PLEASE - for your sake and hers.

I'm not saying I don't want you to pay for college - but you may not be ABLE to do so AND be prepared for the future - and so baby girl may have to get a job and become an expert on scholarships one day - and so much the better if she does. College comes AFTER retirement, not before. No exceptions - too many dang parents out there making themselves a burden on their spoiled kids these days - don't be one.

Ok - so after retirement and college then you focus on paying the house off - but you don't need to be so gazelle then - enjoy life - enjoy your daughter - enjoy knowing that you're teaching her the right lessons by example - and have an exemplary life!

[annakat]

Greebo...you make a lot of sense...I'm not going to be following all of your advice, but it's not because I don't agree with it in principle. I just feel that as I'm in a pretty good starting position, there are some steps I don't mind taking in a slower or less ideal way as a tradeoff for other benefits that don't necessarily fit the DR framework, if that makes sense.

Thanks for the kick in the pants regarding life insurance. It's been on my theoretical list of things to do for a year, and I did start making contacts with insurance companies a couple weeks ago, but I have some follow up calls that I need to make. I will do that today along with canceling some non-essential monthly services I'm ready to do without. Truthfully I know that my family would be able to take care of my daughter if something happened to me, which has probably contributed to a lack of urgency on my part, but obviously it's my responsibility, not theirs, and I need to deal with it now.

I did put $1,000 in a 529 last night, before you replied. I realize I probably shouldn't have, logically, for all the reasons you said. However, that one-time $1,000 will delay my debt repayment by AT MOST two months, and the snowball I plan to apply to my debt will be big enough that I will be able to immediately fund retirement at 15% of gross once it's freed up. In return for that two month delay in my retirement funding, I get a great deal of emotional comfort, whether or not it was the most logical choice.

I'm also not going to sell the car. I've thought about it before you suggested it - and, like going back to full-time work, it's something I would do in a heartbeat if I was in trouble but do not feel is absolutely necessary given my situation. Yes, it would take some months off my debt, but I'm willing to live with 1.47% interest rates for a few months longer and keep my car.

I did log on and suspend retirement contributions last night. I had to go through a few "are you sure you want to do this?" confirmation screens, but I did it. I won't see the effect until the end of the month, but that will be in time for my next loan payment due date. Unfortunately, if I pay online as I would prefer, the bank that has my loans doesn't have an option to apply the extra to the principal. If I send in a check, there's a box to check on the bill stub. So, it's back to check writing for that payment.

My next task, after insurance, will be to figure out the answer to your question...what is the bare minimum I need to get by if something happened to my job? Once I've got that, I'll be able to pay the rest of my savings to jump start the debt reduction. I also want to double check my income tax withholding. I got back a big refund this year because I didn't adjust my withholding for the impacts of my daughter's birth until November - and since that caused a change in filing status to head of household as well as the additional dependent exemption, it made a huge difference. That refund helped replace some of the savings that had been used for one-time house and moving expenses, but this year I'd much rather not give the IRS the interest-free loan. I don't remember for sure, but I think at the time I finally made the change, I had a question about whether I could claim one more allowance than I was considering, and I don't remember which way I went on the issue.

Finally...I live in Houston...the A/C is one area I'm not willing to scrimp!! I can do without a furnace before A/C...we'd spend a few cold nights a year at my parents', but sweaters and blankets are great too. A/C is a much bigger livability issue.

[Greebo]

Greebo...you make a lot of sense...I'm not going to be following all of your advice

Just kidding - this *is* personal finance. You don't have to follow the DR plan OR my advice (which wasn't pure DR anyway).

I did put $1,000 in a 529 last night, before you replied. I realize I probably shouldn't have, logically

I'm not gonna beat you up over this either - AS LONG as you don't NEGLECT your retirement for the sake of baby girl's education.

I did log on and suspend retirement contributions last night.

Good move - remember - it's temporary - and *arguably* a case could be made against it now that I know your interest rate on the SL's...

I had a question about whether I could claim one more allowance than I was considering, and I don't remember which way I went on the issue.

There is no limit on the number of allowances you can claim, but more than 9 will raise eyebrows.

Finally...I live in Houston...the A/C is one area I'm not willing to scrimp!!

Touche - I'm in Maryland.

[annakat]

There is no limit on the number of allowances you can claim, but more than 9 will raise eyebrows.

Actually, this isn't true. Per IRC section 3402(f)(2)(A), "On or before the commencement date of employment with an employer, the employee shall furnish the employer with a signed withholding exemption certificate relating to the number of withholding exemptions which he claims, which shall in no event exceed the number to which he is entitled." Similarly, the provisions that allow for the withholding to be updated when circumstances change also say that they "shall in no event exceed the number to which he will be, or may reasonably be expected to be, entitled."

The code allows withholding allowances based on the number of dependents and marital status. The code goes on to give the IRS the authority to prescribe regulations granting taxpayers additional withholding allowances after taking into account estimated deductions and credits.

IRC section 6682(a) imposes a $500 penalty for making a statement under section 3402 (ie, on your W-4) which results in a decrease in the amounts deducted and withheld if there was no reasonable basis for such statement.

This is me enjoying a discussion, by the way, not trying to be rude or reject your comments. I'm a CPA who does tax work for a living...but my work is corporate tax, not individual, and the above is based on a quick survey of the code, not extensive research. Still, it seems pretty clear to me.

[Greebo]

My mistake - I'll be more precise in future - thanks!