The banking and finance industry has advertised and talked up debt, and then extended credit where they shouldn't have for decades. They've been saying "you need debt" long enough and loud enough that most everyone believes it's the truth. It's not the truth.
Is it really possible in today's world to live without a credit card? Can you live without debts of any kind? The banking and finance industry would like to answer with a resounding NO! My answer is a resounding YES YOU CAN! You can indeed live debt-free. And now that they've invented debit cards, you don't even have to have one credit card for non-cash, non-check transactions.
What Too Many People Believe
Too many people believe the banking and finance industry. They believe they just can't live without debt.
- A good credit score is essential for survival in the modern world
- You can't have a car without car payments
- You can't live without debt
- Most people are doing okay financially
"Most people are doing okay financially" is the biggest myth the American people have swallowed; hook, line and sinker. Most Americans make a good living, but are up to their eyeballs in debt, or worse. The current U.S. savings rate is -2.2%. That means the average American is spending more than he or she is earning.
We, as a country, are not doing okay financially at all.
What can be done to remedy this serious problem? Dave Ramsey, bestselling author of the book The Total Money Makeover, and host of his popular radio talk show has a great plan. I'll summarize it briefly for you here, but you'll have to read the book to get the full affect and benefit. He has 7 baby steps to take to win with money. I'm on his plan and it's working.
Live Below Your Means
"You can't live without debt" is a myth. You certainly can live without debt, and thousands of people do so each day for their whole lives. Many more are getting out of debt and continuing their lives completely debt-free. Want to know who those people are? People who spend less than they make and save up and pay cash for what they want to buy. If they can't afford to pay cash, they don't buy something until they can afford to pay cash.
Do you want to know why rich people stay rich? Rich people stay rich because they make more than they spend, and they don't buy on credit. They pay cash.
Can an average, middle income person live without debt? You're damn straight they can! It comes down to delayed gratification. If you want something and you can't afford it, you don't buy it until you've saved up enough money to pay for it with cash.
Before embarking on paying off all your debts, save a minimum of $1000 or some amount that you know you will need above that in a savings account to pay for emergencies while you're paying off your debts. If you know you're going to be laid off, put your efforts into an emergency fund to take care of expenses while you find another job. If you have a baby coming and you'll need a few months expenses while one of you takes parental leave from work, save up the amount that parent won't be making during that time.
If you're in debt, you can get out of debt by living below your means and using the money you save by reducing your lifestyle to pay off your debts.
You can temporarily get a second job at night or on weekends, or whenever your schedule allows to make extra money to apply to the debt until it's paid off.
You can also make money to pay off debt by selling some of the stuff lying around your house that you don't need or want anymore.
The harder you buckle down and the more you stick to necessities while paying off debt, the faster you'll have it paid off.
Cash for Emergencies -- Who'd a Thought That Was Possible?
Once you're out of debt, except for the first mortgage on your primary residence (which doesn't exceed 25% of your take-home pay), you need to build an emergency fund of 3-6 months of your monthly expenses (I prefer 6 -12 months) that sits in an interest-baring money market account until you need it for an emergency. Then you pay back the account instead of incurring debt on a credit card and having to pay interest on top of principal. Your emergency fund in the money market is like insurance and it needs to be thought of as insurance. It's not an investment. It's there in case you need it. It can earn interest, that's fine, but it needs to be readily accessible and not subject to fees and penalties to cash it out or the whims of the stock market.
Pay Yourself
Now you're out of debt and you have enough money to tide you over in an emergency. Now what? Start paying yourself for what you'll need to buy instead of paying credit bills.
You need to save for some long-term goals and you need to put money away for when big-ticket items need to be replaced. That means you need savings accounts for:
- homeowners insurance deductible (if it's high, which mine is)
- car replacement (should also include your car insurance deductible)
- furniture and appliances
- vacations
- irregular expenses
- gifts (including Christmas)
- blow money (if you can afford it)
Yes, You Can Have a Car Without Payments
When it's time to buy another car, you use the money in your car replacement fund plus any amount you can get on your old car as a trade-in or sale to purchase a newer car with cash. That may mean you can't buy a $25,000 car the first time you buy a car with cash. You may have to trade in a $1000 car for a $5000 car. Then save up again and next time you'll be able to trade up again. Remember, you'll have plenty of money to save for the things you need and want to buy because you won't have any debt payments except your first home mortgage which accounts for a maximum of 25% of your take-home pay.
Saving for Your Retirement
You should save for your own retirement before you save for your children's college education. There is no financial aid for retirement, except social insecurity. I'm not counting on getting any of that when I reach age 67 in 20 or so years.
How much? 15% of your gross pay, not including any company match. The company match is extra and will make you wealthier, but don't count on it. If you have questions about that, just ask someone who used to work for Enron or Worldcom about the company match. Their's went away with the company's failures. The employee contributions were still there, however, depending on how much was invested in company stock, that is. Don't invest your contributions in company stock. Invest it in the best mutual funds they have available in the plan. See a fee-only registered investment adviser for recommendations about which options you should pick in your employer's plan.
If your company doesn't allow a 15% contribution, put the money into a Roth IRA if you qualify, or a Traditional IRA if you don't. If that still doesn't add up to 15% of your gross pay, put the rest into a regular brokerage account with good, solid investments with long track records of performance above that of the S&P 500 index.
Use a discount broker or put your money with Vanguard, Fidelity or T. Rowe Price directly. A full-service broker will break you with commissions. Depending on the amount you have to invest, you might considered an assets-under-management arrangement with a wealth manager. Your assets will be actively managed and you pay an annual percentage of the balance of those assets. Pay no more than 1% of your asset balance as the annual fee. If you're paying more than 1%, you're paying too much, no matter how well your investments are performing.
There is a humongous amount of college financial aid from grants to loans to work-study jobs, to scholarships to the GI Bill. Pay for your own retirement first!
Saving for the Kids' College
First off, no parent owes a child a college education. I hate to sound like my grandparents, but I walked to school in the snow, bare-foot, 5 miles, uphill, both ways. No, that's exaggerated. But I did put myself through college and incurred less than $10,000 in student loan debt. My sister paid her way through, too. Our parents couldn't afford college for us. They helped whenever they could and they helped big-time by keeping us on their medical and car insurance policies. But as far as room, board, books, supplies and tuition, we were on our own. We got very cozy with the financial aid office in a hurry, and we qualified for lots of it, including work-study jobs. I went to college a year before my sister.
When my sister and I were both in college at the same school, we had the extra car from home to share. It was a 1972 VW Beetle and we were driving it in the early 1980's. We had $5/wk from working on-campus jobs for gas. We only drove when we had to. After spending a couple of years in dorms, we lived in the same two-bedroom apartment within walking distance of school (and it was on the bus route) with a third room-mate. It was cheaper than living in a dorm. We bought meal tickets to eat on campus because groceries were more expensive than eating on campus. We did eat cereal at the apartment and we had to cook on weekends because the cafeterias were closed, but we ate lunch and dinner on campus Monday through Friday. It not only saved us money, it saved us time. If you've been a full-time college student, you know how valuable time is.
The best way to save for your kids' college expenses is in a Coverdell Education IRA. The IRA should be the first investment because if the child doesn't go to college, community college or technical school after high school, it can become a Traditional IRA for their future retirement. If you live in the state of Louisiana, and you're pretty sure at least one child will go to college, the state-run 529 plan is the top one in the nation. It's called START for Student Tuition Assistance and Revenue Trust. It's run by the Louisiana Tuition Trust Authority or LATTA. Louisiana has a state tax deduction for contributions to the accounts and an incentive program that pays a percentage from the state treasury based on your adjusted gross income each year. It's a grant on top of the account's earnings and your contributions. The lower your AGI, the higher the percentage of your annual grant. People with an AGI over a certain amount don't receive the grants, but they still get the state tax deduction for contributions they make to the accounts.
Lots of people argue for the use of 529 plans hands down. They shouldn't. Other states don't offer the tax deductibility of contributions or grants for poorer residents who save. Many are under-performers with unacceptably high expenses and parents would do better to just put money in a regular investment account, even after the tax savings of withdrawing the money tax-free for qualified college expenses. You can put much larger contributions into a 529 plan, $10,000 per year per student. But it doesn't do much good if that money isn't earning the way it could otherwise. You can only put $4000/year into a Coverdell account. But if you put $4000/year into a Coverdell from the time he/she is born until age 17, the contributions add up to $72,000. With earnings compounding the amount is more like $200,640 at 10% per year.
So, I don't buy the 529 plan thing unless there's a good one available to you.
Pay Off the House Early
If you're debt-free, have an emergency fund, are saving for retirement at 15% of your gross pay rate and you're saving for the kids' college expenses, what do you do next?
Use any extra money (which by now you see you have a lot of) to pay extra on the mortgage principal. You'll be surprised how fast your mortgage goes away when you can dedicate a lot of money to the principal because your financial house is in order.
Build Wealth
After you're debt-free, you have an emergency fund, all your major goals are funded, your retirement savings is clipping along, you have plenty for the kids' college expenses, and the house is paid off, what do you do with all that money? You only have groceries, utilities, insurance, clothing, and other spending to pay for. No more house payment. That leaves you quite a chunk of change.
Now you get to use the house payment to build wealth. You take that house payment, or a large portion of it anyway, and invest it in a regular, taxable brokerage account. Invest it wisely. Consult a fee-only registered investment adviser to help you find the best investments.
Then you can take some money out of that vacation fund and sit on the beach while your old house payment is making you rich!
You Don't Need a Credit Score
A good credit score is NOT essential for survival in the modern world. In fact, the best credit score to have is zero. If you have no debt you have no credit score.
This will mean you'll have to get a mortgage company that does in-house, by-hand underwriting to get a home mortgage. But if:
- you've paid your rent and utilities on time every month for two years,
- you have a decent income with no debt,
- you only want to borrow 80% or less of the total price, and
- the payments won't be more than 25% of your take-home pay
