Using money targeted for long term savings is a tempting way to tackle credit card balances and lines of credit that have reached precarious levels. Regrettably, Canadians who rob their savings to pay the bills are usually trading current pleasures for future financial pain. These folks need a spending checkup now. In fact, almost anyone who is trying to save for the long term (and those who ought to, but don’t) can benefit from periodically examining their spending habits.
A spending checkup begins with accounting for the money coming into your household and how it is spent. A cash flow calculator can help with this task. Numerous free calculators are available online, such as Golden Girl Finance’s budget calculator (www.goldengirlfinance.ca) or Globe Investor’s cash flow calculator (www.theglobeandmail.com/globe-investor). These tools are usually based on monthly spending. Users enter their income from all sources; expenses such as a mortgage, food and car loan payments, and savings such as RRSP and TFSA contributions. The calculator spits out the net cash balance at the end of the month.
If you are diverting money intended for long term savings to pay the bills, the calculator will likely show a negative cash balance at month’s end – in other words, you are spending more money than you earn. A two-pronged strategy of cutting spending and reducing debt is the best prescription for righting an income/expense imbalance and freeing up cash to funnel into savings.
Start by reviewing the expenses gathered for your spending checkup to find places to cut. Nice-to-haves such as a gym membership, a daily latte at Starbucks or a regular manicure are obvious things to chop. Fewer restaurant meals, leaner cable TV packages and watching a movie at home instead of an evening out are other examples.
Next, look at all your debts and the interest rate and terms for each. Among them could be mortgage payments, student loans, credit card balances, lines of credit or personal loans. Tackling debt is often the key to freeing up funds and getting your long term savings on track.
As a rule of thumb, you should begin by paying off the highest-interest-rate debt first. This usually means eliminating outstanding credit card balances. Using the Globe’s credit card payoff calculator (http://www.theglobeandmail.com/globe-investor/personal-finance/investing-calculators/credit-card-payoff/article2263845) you can test various payment scenarios. For example, if you have an outstanding card balance of $5,000, an 18.5 per cent interest rate and pay $250 a month, you could pay this debt in approximately 24 months at a cost of $1,024 in interest.
You may be able to pay off your debt sooner by asking your card provider for a lower interest rate on your balance. Transferring the outstanding balance to a new card with a low introductory rate on balance transfers is another tactic. Either way, more of your payment will go toward reducing the card balance, not paying interest. If the rate in the above $5,000 example is 9.9 per cent rather than 18.5 per cent, the debt will be eliminated in 21 months and the total interest paid will be $487. The funds previously allocated to reducing debt can then be used to reduce other debt, or allocated to long term savings.
After you have paid off credit card balances, turn your attention to other debts in order from the highest-interest-rate-bearing loan to the lowest. Where possible and permitted in the loan agreement, pay off more than the standard monthly payment to get out of debt faster.
If your debts are overwhelming and you see no way to free up money from your budget to start repaying them, consider consulting a non-profit credit counselling agency. These firms specialize in helping people with debt problems. After reviewing a client’s finances, a credit counsellor will develop a personal debt elimination plan that could involve such things as debt consolidation into one loan with an overall lower interest rate.
Once you have tamed the debt dragon, you’ll want to keep the beast under control. Depending on your spending habits, this could mean shutting down lines of credit, cutting up credit cards or tracking your finances more closely using money management tools such as www.mint.com. It should mean never using your credit card to take out cash since the interest charged on cash advances is typically an exorbitant 19 per cent to 22 per cent.
Kelvin Mangaroo of RateSupermarket.ca recommends that card holders check their monthly statements carefully to confirm that the charges are for items they did, in fact, buy and there are no unwanted fees such as credit card insurance.
Resolving to balance income and spending and to contribute regularly to your long term savings account in 2012 could be the best New Year’s resolutions you will ever make.
Gail Bebee is the author of No Hype: The Straight Goods on Investing Your Money. Visit www.gailbebee.com