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For a Budget That Works, Get Control of Your Debt

Q: I am a single, 38-year-old mother of a college student and I make about $80,000 a year, which isn’t too bad, considering my upbringing. My parents were alcoholics, and thus I never had a financial role model. Now that I am making decent money, I need to know how to spend it appropriately. Even though I bring home $4,000 a month, you would think that I make minimum wage if you saw my house and the way I live.

I think the problem is that I spend a lot of money on wasteful things, such as eating out. I try to track my spending but don’t do it consistently. I would like to stop wasting money and buy a bigger, better home than my current townhouse. I spend $845 on my mortgage, including taxes and insurance. I have two car payments, totaling $700, plus $200 a month for insurance; utilities of $200; a home equity line of credit payment of $200; and a student loan payment of $200. I also have $4,000 in credit card debt. I contribute 6% to my company 401(k), which has a 3% match, but I don’t have an emergency fund. I know I should be paying myself first, but I don’t know how much. I’m just at a loss. Can you help?

A: First, give yourself credit for what you’re doing right. You’ve bought an affordable home, you’re keeping up with the payments, and you’re saving for retirement.

Your big problem is your debt. Your car costs alone are high, given your income and other expenses. That $200 payment on an interest-only home equity line of credit indicates that you’re carrying substantial debt there as well. And the proper amount of credit card debt is zero. All these indicate that you’re living above your means, despite how you might feel.

If you want a budget that works, get your “must have” expenses down to 50% of your take-home pay. That includes your housing, transportation (including gas), utilities, food, insurance, and minimum loan payments. Then you can devote 30% to “wants,” such as clothing, vacations, entertainment, and dining out. The remaining 20% of your pay goes to savings and debt repayment, starting with that credit card debt. (Harvard bankruptcy expert Elizabeth Warren and her daughter, Amelia Warren Tyagi, explain this budgeting system in their excellent book All Your Worth [Free Press, 2005].)

A “must have” is any expense that you can’t skip for several months without serious, immediate consequences. Failing to pay the minimums on your loans, for example, would result in trashed credit, at the very least, and you could face lawsuits, wage garnishment, and foreclosure. Not paying your insurance premiums would result in a lapse in coverage that would leave you vulnerable to catastrophic costs in case of an accident or illness.

A “want,” by contrast, is any expense you can do without, at least for awhile. You may think you “need” new shoes, for example, but you likely have enough in your closet that you won’t have to go barefoot in the snow if you don’t go shopping for awhile.

The last category, for savings and debt, underscores how important it is to pay off our past (our debt) while simultaneously saving for our future. Exactly how you divvy up this 20% is up to you, but at least some money should continue to go into your retirement accoun.

Getting debt, especially auto debt, under control can be difficult. Ideally, you’d sell the two cars and buy one less expensive replacement (your college student can take the bus). But often people with high car payments are “upside down,” owing more than their cars are worth. If they tried to sell their cars to buy cheaper ones, they would need to come up with the cash to pay off their loans, in addition to the money they’d need for down payments on the replacement vehicles. If that’s your situation, it may be best to “drive out of the loans” by continuing to make the payments until you have some equity in the cars. Your college student could get a job and help contribute to the cost of her car. If that’s not possible, you could sell hers as soon as you have some equity in the vehicle and keep the other for several more years until you’ve saved up cash for a replacement.

Consistently tracking your expenses will help you identify areas of over-spending and stay within your budget. If your current method isn’t working, consider using an online site such as Mint.com, which automatically gathers and tallies your bank and credit card transactions.

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