Question e-mailed in by Globe reader Scott: I am currently debt-free and traditionally a strong saver, but as a new homeowner with potential for unexpected surprises, how can I prepare for cash flow issues and avoid having to tap family/friends or expensive credit cards? I’d love to preserve my good credit and minimize interest costs.
Answer from Shannon Lee Simmons, a financial planner and founder of The New School of Finance in Toronto: Home ownership can be a good investment but it definitely comes with additional costs when compared with renting. As an owner, it’s stressful – and expensive – to find a leak in your bathroom tiles, frozen pipes in the winter, plumbing issues or a crack in the foundation of your home.
Here are some tips to try to stay ahead of it so that those expenses don’t end up on credit cards and lines of credit.
1. Keep emergency savings accessible
Sounds like you’re a good saver, which is great. My first tip is to keep the portion of your savings earmarked for home-related emergencies liquid and accessible. Often I see people empty out emergency savings accounts that are only earning 1 to 2 per cent and put that money into registered retirement savings plans (RRSPs) – especially during RRSP season. But, if you run into an emergency and all of your money is either invested or in accounts like an RRSP, it will be harder for you to easily access that money without paying tax penalties or risk selling your investments at a loss.
For those who have regular paycheques, try putting a portion of your savings away monthly in safe, liquid and accessible places, such as a high interest saving account. If you’re self employed, you may want to put a certain percentage of your after-tax income aside, like 3 to 5 per cent, for short-term emergency savings.
2. Ensure your fixed expenses are less than 55 per cent of your take-home pay
Fixed expenses are your bills. The things you must pay because you have signed a contract. Things like housing bills, car payments, minimum debt payments, insurance premiums, child care, utilities and subscriptions. The amount to be paid is known in advance, unlike things such as groceries, gas, toiletries, clothes and other enjoyable, discretionary expenses. Your fixed expenses shouldn’t be more than 55 per cent of your take-home pay. If you’re in the child care years, that’s a really tall order so I’ll give you a bit of a hall pass. Take the child care out and ensure that you’re other fixed expenses are below 55 per cent of your take-home pay. Child care will end at some point. Hurray!
When your fixed expenses are more than 55 per cent, more than half your income is spent before you even get to decide to save or spend it. It means less money for daily life and emergencies. The lower your fixed expenses, the more likely you are to have free cash flow that can handle those spikes in spending that home ownership brings.
3. Don’t think of your line of credit as your emergency savings.
I hear this all the time. “I don’t need emergency savings because we have the line of credit.” No! This is a dangerous mindset. There’s something truly unsettling about bailing yourself out of an emergency with debt. It’s like kicking yourself while you’re already financially down. It robs you of your ability to feel in control of your money.
Having your liquid, safe and boring emergency account hanging out on the sidelines of your chequing account will act like a warm blanket of calm when a household emergency hits. Need a plumber? No problem. Call him or her, secure in the knowledge that you can afford to pay them.
4. Try bringing in some additional income
You’ve got an asset – work it. Your home is your haven but can also be a cash cow. Yes, it may be going up in value on paper, but you don’t get to reap that financial reward until you sell. In the meantime, you still have to pay for all the costs of running that house. Is there a basement apartment you can rent out? Do it! If not, rent out your place on a short-term hotelling site and bring in some extra cash. This money is taxable but the after-tax amount can go directly to your emergency account to better offset the cost of ownership.
Can you stay at your parents/friends/family/whoever’s house for a weekend every now and then? Can you rent out your place while you’re on vacation? Get creative.
5. Remember that cosmetic upgrades are not home repair emergencies.
Sure, we all want a Pinterest-worthy living room, but cosmetic upgrades and decor updates are not emergencies and you shouldn’t use your repair savings money toward these and they shouldn’t go on lines of credit. Save up for these in a separate account and then spend the money guilt- and worry-free.
You can also join the Gen Y Money Facebook group.