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Financial planning: What should you do with your money?

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Photo illustration / Creativ Studio Heinemann / Westend61 / Newscom / File

(Read caption) Today's Reader's Mailbag includes several questions about financial planning from different points in life. As financial needs change through time, there's no one answer for how to save, invest, and spend your money.

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Q1: Joint expenses and loans
My soon to be fiancé and I recently started living together. We live in a very expensive part of the country in a small apartment. He is currently in grad school. It is an expensive program, and he has some student loans to cover tuition and living expenses. We did Financial Peace University after he had accepted the loans. Neither of us have any consumer debt. We have budgeted so that he is spending way less than the loan money he has been given (about $4000 less each term, so about $12 K less each year of a two year program), and I am spending less than I earn as well. The extra money from his loans is sitting in his bank account, and he will use it to immediately start paying down the loans after graduation. I currently work full-time at a stable job, making about $46K. We currently split the expenses down the middle—me paying for my half with my paycheck, him paying for his half with his loan money. I am currently putting about $1000 into my savings each month. He has about 20K saved in his savings from before grad school, not including the student loan money. I have about $15K in my emergency fund and feel comfortable with that number. My questions: Would it be better for me to pay for all of our joint living expenses for the remainder of his degree, so that he can use less of his loan money, or is it more important that I continue to save that 1000 per month? What would be the best way for us to jointly manage our money and the loans? For whatever reason, it seems like a really confusing decision for us.
- Samantha

You’re moving from a situation where you have separate finances to a situation where your finances are essentially joined together. In that event, you should be choosing whatever path results in the best overall financial picture for the two of you.

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If your fiance is taking out extra loans solely to pay for the rent, that’s not a great long-term financial move, particularly if you have an emergency fund large enough to cover a few months’ worth of living expenses. Assuming the two of you are really in this for the long haul, the smartest move would be for you to cover most or perhaps all of the rent, minimizing his loans.

Before you make that move, though, be absolutely sure that the two of you are in this for the long haul. If you continue to date until he has his degree and then you break it off, you essentially just paid for part of the college degree of your ex-boyfriend.

Q2: Buying a house right now
We live in the Washington, DC area and are considering buying a house. We plan to stay in the area for at least the next 5 years, though there may be a 1-year break for me to go to grad school (we’d rent out our place). If it worked financially, we’d consider keeping this property as a rental even after moving out of the area.

Despite the planned break for grad school and thoughts of moving in 5 years, we’re starting to seriously consider buying in the area. Our apartment rent is set to increase substantially in the next two months, interest rates are very low, house prices have dropped (they’re still expensive, but as reasonable as I’ve seen in the DC area), and we think housing in this area can only stand to appreciate over the longer term. A house in the area we’re focused on – for reasons of great schools, good potential resale value, and reasonable commute – will set us back $350,000-400,000. We have cash for a down payment of ~15-18%. Our expected mortgage payment would be less than our monthly rent, though we know there are a lot more costs that come with home ownership.

My biggest hesitation is making a financial decision like this when we have significant student loans to pay back. Unfortunately, my husband racked up a lot of student debt between undergrad and grad schools – it’s around $200,000, mostly at 4-5% interest rates with some smaller amounts at higher rates (8%). We know we have to pay this back, and we are. We currently pay around $1,000/month toward the student debt; as our income rises, we may have to pay up to $2,000/month. Our only other debt is a car payment ($150/month). We bring home about $6,500-7,000/month after taxes, insurance premiums, and 401k savings.

Given the student debt we have left to pay off, is it a stupid idea to buy a house?

As a follow up question, should we be focused more on paying off the student loans than on funding retirement plans?
- Tori

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With that big of a student loan over your head, your housing option should be the one that costs you the least amount, whatever that may be. I think you need to sit down and investigate the complete cost of home ownership for the home you’re considering.

How much will insurance be? How about homeowner’s association fees? Property taxes? These are three areas that you can get an estimate for right now – and I’m almost sure you’ll find that the cost, even with these categories, goes way up from what you’re spending right now.

If you can find an option that costs you less than what you’re spending right now, go for it.

As for your retirement plan versus your student loans, I would make sure that you’re socking away 10% of your income towards retirement. Anything beyond that should be going towards the loans.

Q3: Keepsake distribution
My mother is going to be entering a retirement home after the Christmas season. She will be selling her home and some of the possessions in it. This will be our last Christmas at the old house.

She’s told me, my siblings, and all of her grandchildren that she’s going to be distributing all of the family keepsakes and personal items in the house this Christmas. We don’t know how she’s going to go about it and some of us are a bit concerned that there will be fighting over a few key items. Do you have any suggestions on how to handle this in advance so that our last Christmas there isn’t ruined?
- Millie

I would suggest that your mother decide before you all arrive what items she’s intending to distribute to whom. Let it be entirely her decision – after all, it is her things.

If there are items people want that aren’t claimed, I would suggest having a drawing to determine an order of people. The first person in that drawing gets to claim an heirloom of their choice, followed by the next person and so on.

All of you love your mother and her home and all of you will want an item to remember things by. Keep that in mind and it’ll go smoother.

Q4: Savings or student loans?
My fiancee and I are both 23 and living separately at our parents’ houses. As such, the only expenses we really have are student loans and car payments. She makes less than I do, and has about the same in student loans, with a smaller monthly car payment. In the past year, because I’ve had little other expenses, I’ve been putting as much as I can on the student loans as possible, to the tune of $12,000, or $1000 a month, which is well above the minimum payment. Also, I’ve been putting 8% of my paycheck to my 401(k), which is a little more than the company matches. Again, I’m taking advantage of the fact I have few other expenses now, so I’m doing as much as I can in other areas. My fiancee and I opened a joint savings account together, which grows $600 per month, and we’ve got about $3500 in there. It’s our wedding/house starter money.

Because I’m paying off loans so quickly, I really haven’t saved much, personally, in about a year. I still have about $12,000 in savings, and my fiancee has about $8,000.

My question was this: should I keep paying off the student loans at $1000 per month, or should I slow it down a bit and ramp up my savings? Also, one of my savings accounts (about $6000) has been sitting around, doing nothing but earning minimal interest. I was thinking about either Treasury notes (which ties up the money for a year) or a shorter CD (higher interest than my regular savings, but with the ability to get to the money after a shorter time). My fiancee doesn’t really like the idea of either, because she thinks we’ll need that money VERY shortly, when we haven’t really looked at houses or anything.
- Josh

This is a moot question if you and your fiancee aren’t on the same page about what your financial future holds. The first thing you need to do is sit down together and talk about where you two intend to be in a year, in five years, and so on. Without knowing that – and knowing when you intend to buy a home together, get married, and so forth – you can’t plan appropriately with your money.

If your home ownership is more than two years or so away, I’d probably spend 2011 knocking off those student loans. Being debt free is something you’ll never regret, plus it’ll give you the freedom to start saving in earnest for whatever may come.

If your wife-to-be is seriously thinking of buying a home in the next few months, then make minimal student loan payments and save every drop of cash that you can. You’ll need it.

Q5: Homebuyer’s tax credit repayment
My husband (fiance at the time) bought a house in March 2009 for 160,000 and qualified for the 8,000 home tax credit. It had been his dream to remodel an older home and so for the past year and a half, we have completely replaced and updated everything. Unfortunately, although we love our house, we have really grown to dislike the neighborhood (broken into once and have had several items stolen from the sheds, yard, etc) and are looking to move to a nicer neighborhood. Anyway, we have probably put $40,000 into the renovations and since we will be selling (hopefully!) before having lived in the house for 36 months, we will have to pay back that 8,000. However, IRS form 5405 states that we would not have to pay back the credit if we do not have a “gain on the sale (as figured after reducing the basis of my home by the credit I claimed in 2008)”. We are hoping to sell our house for 190,000 and so, would be losing money with all the renovations. We still have our receipts and everything. My question is, do we have to pay back the tax credit?
- Emily

I consulted a tax professional friend of mine and he stated that he believed you would have to pay back the credit.

In his words, “the rule is written to prevent exactly what they did which is increase their home value through renovation then flip it quickly.”

If you sell it within the 36 month time period, expect to pay back the credit.

Q6: Emergency fund size
We have a $65K emergency fund, which represents about 9 months of expenses. We also own a rental property that is completely paid for. Our only debt is a truck payment of $394 a month (0% interest; 3 years left on the loan). Since we have the emergency fund in placed, I have been paying $1K extra a month on our mortgage principal. As I read your blog, especially about the readers who are struggling financially to cover basic necessities, I’ve become a little paranoid and I’m now wondering if we should stop paying so much money on the principal and add more to the emergency fund. I’m a teacher and my husband is a school bus driver. Our combined monthly net income is about $7k, from September through June and this amount does not include the income we make our rental property, which is about $1,500 when both apartments are rented. We pay about $5K every five months for our son’s college tuition. He opted for a community college and will be attending a public university nearby to save on room and board. What’s your take? Should we put more money in the emergency fund and reduce the amount paid on the loan pricipal?
- Deborah

I would make sure that you have enough in your emergency fund to cover at least three months’ worth of all of your expenses. The cash total in your account should cover every bill that you would expect to come your way over a three month period – mortgage payments, utilities, taxes, food, car payments, and so on. I would encourage you to perhaps even have four or five months’ worth.

I don’t know what that number is – you’ll have to calculate it yourself. However, I think your emergency fund is probably large enough in this case.

However, if you do feel uncomfortable with the size of your emergency fund, it does not harm anything to increase the size of it.

Q7: Investing baby steps
I’m a young student (around 20) and I’m starting to invest my hard earned income. I’m lucky to live in my parents’ house, so I don’t have rent or grocery to pay. Therefore, I think the timming is right to start. What book would you recommend me to read to get a better knowledge of investment (read here placement, investment fund, bond, etc.)?
- Gabriel

For starters, you need to set a goal, and I’m going to speculate that one of those goals is to move out from your parents’ house.

If you have enough extra money that you’re starting to sock it away in “investments,” you need to be looking at a timeline for your independence from them.

My suggestion is to sit down with them and have a face-to-face talk about what the expectations are and what the plan is for you becoming fully independent. That will help you to figure out what exactly you should be saving for.

Q8: Underwater questions
Two and a half years ago, my husband and I purchased a house. The market in our area was just beginning to show signs of faltering, but we got a house we love for an affordable monthly payment. At the time we only put down 8%, got a 30 year mortgage at 6% and do not pay PMI (our credit union does not charge PMI on any mortgage it issues). With the interest rates being so low now, I was considering attempting a refinance. However, looking at the recent home sales in the neighborhood, there is a good chance that our house will appraise at or below the amount we owe on it. So onto my questions.

If our house appraises for less than we owe on it, are there repercussions? I’m guessing it means refinancing goes out the window, but can it effect our existing mortgage?

Let’s say our house appraises better than we hope. My understanding of PMI is that it is effectively an higher interest rate for the years of payments before you have paid off 20% of your home’s value. Is it worth it to move to a loan with PMI if the PMI plus the interest paid is less than the interest we’re paying now? Is PMI tax deductible like mortgage interest is?
- Margot

If your home appraises for less than you owe on it, it means you’re underwater. It doesn’t directly change a thing about your mortgage agreement.

The problem is that it will be very difficult to move your mortgage elsewhere, as a home mortgage relies on having an asset behind it that’s worth at least somewhat more than the amount loaned out. They’re not going to loan you more money than your home is worth.

If your home is appraised for more than the mortgage, then you may be able to move it elsewhere. There will be different kinds of offers on the table, some with PMI and some without (but with higher interest rates). I wouldn’t move it unless you get one that reduces your interest rate by more than 1% and has a combined interest plus PMI rate that’s lower than your current rate.

Q9: Saving priority before moving
I try to be very diligent about saving. Every month I automatically contribute to the follow accounts

Roth IRA (going to max out for the year)
401K (small ammount because my employer doesn’t match)
An index fund ($300 per month with the intention of this account being a down payment for a house 10 years from now)
$150 a month to a savings account for long term goals
$100 a month for emergency fund
A variable amount for other savings accounts (Christmas gifts, vacation, engagement ring)

I live with my girlfriend in San Francisco and I intend to marry her in a few years. She is applying to graduate school in New York. If she gets in I intend to move with her. My question is should I save less in the index fund for the house deposit and instead start putting more money into the more accessible savings account so I can use the money if I need to for a move?

My company has an office in New York and would likely provide me with some sort of stipend for moving.
- Joe

Whenever you move, it’s always a great idea to have some liquidity. If you think that a move is coming up soon, I would start buffing up your cash savings.

Why? Every move I’ve ever seen involves tons of little expenses, from restocking a household to utility deposits. There will be a healthy outpouring of cash during that timeframe and if it’s in the near future, you need to have the cash to cover it.

Your index fund can wait – it’s long term anyway. Prepare for this short term spending situation.

Q10: Savings rates and journeys
I started reading the archives of your blog, and came to the realization that we are in a similar situation as you were when you started the blog – credit card debt, student loans, a decent household income, auto loans, a little savings, bought a house a year ago, first child on the way. We have tried to start paying down debt aggresively in the past, but something always derailed us (saving cash for a down payment for our house, travel, a job loss). We are now in what I feel is a great position to start paying down debt and to get our financial lives started in the right direction.

My question is in two unrelated parts. First, going back to the beginning of your journey in your archives, you made mention in many of your posts about placing your savings, and/or your emergency fund, in a high-yield savings account, with rates in the 4-5% range. You wrote this stuff 3-4 years ago, however, and those type of rates for savings accounts don’t exist anymore. The best I can seem to find is in the 1.3% range. Do you have any recommendations of higher-yield savings accounts, or other savings options with similar liquidity and a higher rate? Our emergency fund is currently in a savings account earning 0.05% APY, which is a joke (we earned four cents on $1000 last month).

My second question is more about the financial journey. I really enjoy reading your blog, others like it, and have previously read a few of the books you’ve reviewed in the past. I’m constantly looking for ways to save money, create more income, and seeing when certain debts will disappear. My problem is that I just can’t wait for these things to happen. I’m confident enough in my job, my wife’s job, and our plan, that I can see the day when we’re debt free (except for our mortgage and some very low-interest student loans) and can begin expanding our emergency fund to cover 6 months of expenses, and then begin investing. The problem is, I want to see it now. For some reason, I’m becoming somewhat obsessive over this (I happen to enjoy the subject, the reading, and the numbers), and just can’t wait for these plans to become a reality. It’s not adversely affecting my life, or relationship, or anything like that, but I always seem to be running numbers in my head. Maybe I’m being perfectly normal about it, but any advice on patience? I know this is supposed to take years. I just can’t stand to wait that long…
- Kevin

Those rates existed in 2007. Thanks to the economic conditions since then and the Federal Reserve’s response to them, these rates have dropped through the floor. The best you’re going to find that isn’t some sort of teaser or isn’t combined with some sort of restrictions is probably in that 1.3% range right now.

As for having patience when it comes to watching your financial progress, my suggestion is to calculate your net worth very, very frequently and chart it in comparison to your previous calculation. Do it each and every pay period.

There was a time in my own financial journey where I felt very frustrated by the slow progress. An intense focus on my net worth, particularly in terms of comparing it to my previous net worth, helped me get through it and really understand how my little steps were becoming bigger and bigger and bigger.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag. However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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