I recently came across an article in the Black Enterprise where they teamed a family who had some financial goals with a financial advisor. I thought it would be interesting to share this family’s financial circumstances and goals, the advice given by the financial advisor, and the advice I would have given this family.
The family is a young couple—both 29 years old with two children, ages 1 and 3. Husband works full time and has an annual income of $38,000. Wife works part time and has an annual income of $3,000. Their total household income is $41,000. This happens to be the average household income in America. They are currently about $71,000 in debt. This includes $64,000 in student loans and $6,800 in credit cards.
For the past 3-years, they have been deferring payments on $50,000 of the $64,000 student loan balance. They recently qualified for an affordable home loan program. They put $2,000 down on a $237,000 two-family home that is currently under construction. Their home should be completed by year-end. They plan to live in one of the units and generate rental income from the other unit. In the near future, they would like to utilize the equity in their home to purchase more rental property. They’re frustrated with being boggled down with debt. One of their goals is to save for their children’s college education so that their children don’t start life off in the hole like the parents did.
Financial Professional’s advice—Focus on reducing debt. Financial Advisor says that wife should return to work where she was earning $24,000 a year. This will take her financial contribution from $200 per month to $1,200 per month. The new job will trigger repayment of the student loan that is in deferment of about $500 per month. She will still have enough money to payoff other debts.
My advice—I agree with the Financial Advisor. Returning to work would be a good thing. It will create some wiggle room in their budget and help them with their goals of getting out of debt. I would encourage them to first save about $1,000 to $1,500 in a savings account to provide a cushion to deal with life’s unexpected, unpredictable circumstances that we all face from time to time. This will help them avoid borrowing money in the future in the event something comes up. From there I would help them create a very specific, systematic plan to prioritize this debt and knock it out in record time—preferably in 2-years or less. Thus, allowing her to return home to raise the kids if she chooses too.
Financial Professional’s advice—When the Bakers’ current lease expires, they should move in with husband’s parents for six months until their house is finished. This will reduce their living expenses and provide affordable in-house childcare because husband’s mother is retiring and is willing to baby sit. Advisor forecast that moving in with mom will save about $400 each month for the next 6-months. Financial Advisor also suggests they get an interest only mortgage. The interest only mortgage would provide a lower monthly payment because there’s no principal reduction. This will allow them to save.
My advice—I would suggest that they take advantage of the affordable childcare provided by mom whether they move in with mom or not. Daycare can be extremely expensive for two children—upward to $1,500 per month. I’m all for saving money. However, I’m reluctant to suggest they move in with mom in this particular instance. I would make this recommendation only if they were willing to make more of a permanent reduction in lifestyle cost. Granted moving in with mom will allow them to save about $2,400 over the six-month period. This process will not psychologically prepare them for the increase in housing expenses they will soon take on in the next 6-months. I’m more opt to suggest they extend the lease for 6-months. I would recommend that they total what their new housing expenses will be including mortgage, taxes, insurance, gas, water, maintenance and other miscellaneous expenses not commonly associated with renting a property. It will undoubtedly be more. Subtract their current housing expenses from their future housing expenses and save the difference. This will do two things. It will help them get use to the idea of having higher housing cost and it will allow them to save that same $2,400 or more toward moving expenses over the next 6-months. Regarding the interest only mortgage—Bad Idea! Anyone considering an interest only mortgage is admitting out loud—I cannot afford this house. Interest only products are generally tied to an adjustable rate loan, which is yet another Bad Idea. How about a more affordable home on a fixed rate mortgage product where your monthly mortgage, taxes and insurance payments does not exceed 35-percent (preferably 25-percent) of your take home pay. I realize the other unit will produce rental income. However you should take on expenses based on your financial ability to repay. If you don’t, you’re in for a ride when you come across dead beat tenants who are always late and often times miss payments or when you’re experiencing a longer than expected vacancy. Lastly, a $237,000 mortgage seems a bit pricey for a household income of $41,000.
Financial Advisors advice—Stop saving toward children’s college fund until all debts are paid. However any cash gifts should be deposited in a 529–plan.
My advice—I agree, stop saving toward children’s college fund until all debt with the exception of mortgage is paid. I believe all cash gifts should be deposited in an ESA—Educational Saving Account. They are more flexible and easier to understand than a 529–plan. Only if you’re contributing more than $2,000 per year or if you make more than $200,000 per year should you consider the 529 before the ESA. I would add that as the children move from daycare to kindergarten, the money that was going toward daycare should be directed toward their college fund.
(Mortgage and Money Coach Damon is owner of ACE Financial. He can be reached at 412-856-1183.)