Mary writes in:

My husband and I have been debt free for seven years. Hooray! We cancelled all of our credit cards in 2001 and paid off our home mortgage in 2002.

A few weeks ago, our homeowners insurance premium went up substantially. I called our agent to ask why and he told me that our premium was automatically raised because our credit score was low.

I got worried and checked our credit report at annualcreditreport.com (as you suggested before) and found nothing at all on our credit report. So, I called our agent back and told him the story. He did some follow-up and found that because we didn’t have any outstanding credit of any kind on our credit report, they couldn’t verify that we were responsible payers, thus we were placed into a higher risk category.

This seems nonsensical! I am shopping around for new insurance but I wanted to know what you thought of this policy.

Obviously, on an individual level, this is nonsensical. A person with no debt at all and a long history of never having debt is the type of person that ought to be considered a great client for an insurance company. I can’t think of anything that screams “stable and reliable” than a person without any debt.

Yet, if you step back and look at the broader view of society, this policy does somewhat make sense.

First of all, the insurance company has to have standard rules and practices for setting their rates. They have to know cold the risks associated with different factors, from the color of the car to the reliability of the driver. When they know these risks, then they can calculate the exact rate to charge to simultaneously be competitive with other companies and earn a profit for themselves.

Hand in hand with that is a society that lives and thrives on personal debt. Between automobile loans, student loans, consumer loans, mortgages, and credit card debt, the vast majority of Americans possess some form of debt in their lives. Given that as a baseline, it’s reasonable to argue that a person who pays their debts in a timely fashion is more reliable – and thus less of a risk – than a person who does not.

That information is packaged up nicely in our credit reports and usually calculated down to a single number that represents how efficient we are at paying our debts – our credit score. Insurance companies will often take this score and run with it, using it as a basis for determining our premiums.

Unfortunately, a person’s credit score is higher if they have small, reasonable debts and always make their payments instead of having no debt at all.

The next question, obviously, is how can a debt-free person improve their credit score without getting into additional debt? There is no easy answer to that question.

The simplest solution is to simply use credit for the most routine of purchases – groceries, gas, and so forth – and to pay off that debt in full each and every month. One way to do this – to keep things under control – is to simply get a credit card at your preferred gas station, use that card just to fill up on gas and nothing else, and then pay off the card each month. So, for example, you might have a BP card, and you would only use that card at BP.

A second option would be to stop by your local credit union and talk to a loan officer. They may be able to develop some form of no-risk personal loan for you based on using some of the assets you have as collateral. You then just leave the money at the credit union in an account and have all payments for your loan deducted from that account. If you have such assets, the actual cost of this would be minimal.

Yes, society has stacked the deck a bit against people with no debt, as there are many financial incentives to carry debt. With a little clever thinking, though, such risks can be pushed back.

Iris writes in:

I was wondering if you could comment on the debt reduction/elimination ads I keep seeing on tv. Are these companies reputable? Are they doing anything that I can’t do myself? I would hate to pay a huge fee for something I could do myself. I would really like to reduce our debt load so I can free up more funds in our budget every month for, say, groceries. Advice?

The first and most important thing to note is that not all debt reduction and elimination programs are the same. Although they’re often collected under the same grouping, these programs tend to provide an array of services.

Unfortunately, all of the services provided are either dangerous or easily replaced by free materials.

One common service provided is education inhow to pay off debt. They explain, in great detail, how to create your own debt repayment plan and stick to it. They provide workbooks and other information to make the process as painless as possible.

The catch here is that you’re paying a lot for materials that can be found at the library or online for free or even at your local bookstore for a much lower price. If this is what you need, start off by checking The Total Money Makeover out of the library.

Another common service provided is direct management of your debts. Instead of teaching you how to make a debt repayment plan, they essentially take charge of all of your debts, do it for you, and provide you with a single monthly bill.

The catch here is that the fee for their service is often very high, usually running into the thousands of dollars. Considering that a person can make up such a debt repayment plan themselves for free, this is a pricey service. There can be some merit here, though, if a person simply wants an “enforcer” or a “coach” to help them do it.

A third common practice is renegotiation of debts. This is often the tactic used by programs that promise very rapid elimination of your debt. They’ll negotiate your debt for you, often functioning as a debt collection agency themselves, then you pay them a lower, negotiated amount.

The catch here is that this functions as a nuclear bomb on your credit report. Your credit score will be in the trash for years if you take this approach. The actual amount you have to pay for this debt is less, but any debts you take out in the next seven years – or any insurance you take out – will cost you more, and any applications you make where your credit report is used as a factor will not reflect well on you.

In short, all of these plans do what they advertise, but they often cost far more than they’re worth.

The key thing to remember is this: no debt reduction or elimination plan is worth anything if it’s not paired with a sincere, long-term change in your own spending. If you’re merely using these services to give yourself some breathing room without changing your spending behaviors into a more frugal spend-less-than-you-earn attitude, it’s just a matter of time before you’re back in the same boat again – and often in worse shape if you’re back in this boat with poor credit.

On the other hand, if you first get your personal spending habits into shape and truly go forward with a “spend less than you earn” mindset, you can handle the debt repayment plan yourself. They’re easy to set up, won’t destroy your credit, and don’t cost an arm and a leg, either.

Good luck.

A while back (has it been almost eighteen months already?), I wrote a very detailed article about coming up with a debt repayment plan. This plan works – it’s what I did when I realized that I was in serious financial trouble and needed to overcome it.

Yet it’s not the first step in the process. The absolute first step in getting out of a bad debt situation is to break your personal cycle of debt usage.

If you’re not willing to completely stop using debt and to spend less than you earn every single month, no debt repayment plan of any kind will help you.

This is often harder than it sounds. For many people who find themselves in a desperate debt situation, living above their means is simply a way of life. I know that it certainly was for me. I wouldn’t even think twice about spending small amounts of money and I usually found “good” reasons to spend larger amounts as well.

I firmly believed that I deserved lots of material items and the simple fact that I didn’t actually have the money to pay for them didn’t matter. I had credit, after all.

I had part of it right: I did deserve the good things in life. What I didn’t understand, though, is that the good things in life aren’t bought with a credit card.

The good things in life come from having less stress in your life. Stress is derived from a job that you can’t walk away from because you have so many bills to pay. Stress comes from facing a mountain of bills without much cash in your checking account. Stress comes from wondering whether or not you’re going to be able to make rent or make the mortgage payment next month. Stress comes from having more stuff than you can enjoy or possibly deal with. Spending less than you earn alleviates all of these stresses.

That reduced stress helps you across the board. It improves your health. It improves your energy level. It improves your attitude. When you improve in all of these areas, people notice.

When I was in debt, I had all the material trappings I could ever want – but that’s all I had. I stayed up at night worrying about my bills. I was stuck living in a tiny apartment – and even then I was sometimes struggling to pay the rent. I was scared to death to step out of line even one inch at work, which meant that I constantly played it safe, which meant that much of the enjoyment of the job evaporated since I was now doing work I didn’t really want to do. My wife and I got upset with each other quite regularly because of the money issues.

But, by golly, I had myself plenty of electronic gadgets and nice clothes!

Those material items were a prison. They kept me sequestered away from the life I really wanted to lead.

When I realized that those very things that I thought I truly wanted were the very things that were making me unhappy, it became easy to make some changes. I tossed the credit cards, sold off a lot of my gadgets to whack down my debts quickly, and started discovering new things to do.

Who would have ever thought it was more fun to go on a bike ride on a lazy afternoon than to buy yet another barely-played DVD or video game? Even better, when I got home, I wasn’t facing a stack of bills.

The first step towards getting out of debt is to recognize where the real problem lies. It comes from the things you choose to spend your money on – the very things you’ve convinced yourself that you need. Those splurge purchases that are the “spice” of your life are the very things that are causing you to be stressed out, stuck in place, and looking for a way out.

You don’t need that stuff.

Over the past few months, our finances have been in something of a “reset” mode. In the process of taking more control of the advertisements on The Simple Dollar’s website (which is my primary source of income), I had to change billing systems. With my previous primary advertising representative – Google – I would get paid the month after an ad runs – so if an ad runs in May, I would be paid for that ad by the end of June. In April of this year, I switched most of my advertising away from Google to Federated Media, which handles things in a different fashion. Since they run in a campaign-by-campaign fashion, if I run an ad in May, I have to wait until September to receive payment.

So, at the end of April, we made the switch. Thus, at the end of May, I received my last payment from Google – and then received essentially no income during June, July, and August (and much of September, too).

Ouch.

Now, this switch was, in the long run, worthwhile. My monthly income will go up. However, it made for a painful summer. We had to tap strongly into our “opportunity” fund to make this happen – I am very glad that we had such a fund in place to make this transition possible.

But, here we are, at the end of the summer. We now have a depleted “opportunity” fund and we’ve even touched our emergency fund a little bit, but our monthly income is about to return to normal – in fact, perhaps a bit higher than normal.

In other words, this is a perfect time to re-assess our financial goals for the near future.

Over breakfast several days ago, Sarah and I talked about our plans and here’s what we came up with.

By the end of 2009, we intend to replenish our emergency savings and our “opportunity” savings to the balance they held on April 1. Maintaining an “opportunity fund” is something that’s very important to both of us. It allows us to take advantage of opportunities that life throws our way without tapping into our emergency fund, since a great opportunity isn’t really an emergency.

In fact, maintaining our “opportunity fund” was the big reason we elected to finance a Prius early this year instead of paying cash for it. After a lot of thought, we decided that it was better for us over the long term to keep that cash on hand for other opportunities – and it turns out we were right.

However, that leaves us with a strongly depleted opportunity fund – we lived out of it this summer, since we viewed this transition as an opportunity, not an emergency – and even a bit of money taken from the emergency fund, too (to fix a broken-down truck).

Our goal for the rest of the year is to replenish both of these funds to the level they were at prior to this past summer. In terms of our day to day living, it doesn’t mean too much, but it does mean that our excess income will be put directly into savings before anything else. I think it’s very realistic to do this by the end of the year, based on what we expect to bring in over the last four months of 2009.

That brings us back to where we were prior to the “summer of transition,” as I like to call it, but leaves us in better shape than before by far. Our monthly income is higher and even if I chose to shut the site down for some reason, we’d still have three more months’ worth of income already earned to survive off of, which is a much nicer position.

At this point, we’ll turn our attention to our remaining debts.

By the end of 2010, we intend to be debt free except for our mortgage – and that includes replacing our semi-functional truck with a van – while maintaining our fund levels. Sometime in the next year – and it may be sooner rather than later – my truck, which is on the verge of complete breakdown, will be traded in for a late model used minivan and we intend to make up the difference in cash. We’re trying as hard as we can to stretch this out, largely functioning as a one vehicle home at the moment. So, one big priority is making that van purchase happen.

Obviously, my hope is to stretch that purchase out until at least near the end of 2009, at which point paying cash will be relatively easy thanks to our renewed savings.

Once the van is ours and paid for, our only outstanding debts will be our mortgage, the remainder of our Prius (after the down payment and several months’ worth of regular payments), and a single student loan. By the end of 2010, I intend to have the non-mortgage debts paid off, and I’ll celebrate each success right here on The Simple Dollar.

I’m going to essentially use a debt snowball to wipe out these debts, ordering them by interest rate minus any tax benefits. This means the Prius goes first, then the student loan, then…

Yes, the mortgage.

After the other debts are paid off, by the end of 2010 at the latest, I’m going to throw everything I’ve got at the mortgage. We’ve already

The big key is that none of this changes how we live day to day. We’ve basically done the same things day in and day out since 2007 or so. We spend less than we earn (excepting, of course, this summer, where income was quite low by choice). We don’t spend extravagantly. When opportunities present themselves – or we’re faced with emergencies – we just use the cash we already have saved for these purposes.

In short, for us, extra income just means we arrive at our big goals a little quicker. Our dream is to be living in our long-talked-about farmhouse before the kids are finished with grade school – within nine years.

That means daily extravagances keep us from our dreams. Every day we continue to live cheap between now and then is a day we march closer to our goal. Every day we’re able to take advantage of an opportunity that comes our way is a step closer to our goal. Every emergency that doesn’t require us to use plastic means that … well, we’re not closer, but we’re not going back any farther than we have to be.

Frugality underlines everything we do. Sure, we strive to earn more along the way, but if our efforts in that direction mean spending with reckless abandon, we’ll soon find ourselves where we were in 2006 – in a very rough place that takes a long time to climb out of and even longer to reach the things we want. And that’s a scary place to be.

Set goals. Take care of them by living frugally. Get there faster by earning more and taking advantage of opportunities. That’s what it’s all about.

For my birthday a few weeks ago, my wife gave me the board game Agricola. I opened up the box, looked at the abundance of pieces, read through the instruction book, and was immediately worried that the game would be too complicated for us to enjoy.

The first game we tried was pretty miserable. Sarah felt lost and the game was slower than molasses. We weren’t even sure we were going to try it again.

So, a few days later, we did try it again. And something clicked. We started playing it all the time.

In fact, Sarah and I had a “weekend getaway” last weekend (while the grandparents watched our children) and what did we do? We took Agricola along and, one evening, we wound up in our hotel room, kicked back with a bottle of wine, moving sheep around, laughing together and telling jokes.

Romance? In its’ own way, it definitely was.

Nevertheless, Agricola is getting heavy play around these parts as of late. It’s pretty complicated – and you should expect the first game or two to be pretty dull – but after that, it gets better. Much better.

Here are some great personal finance articles of the last week.

I’m Losing 50 Bucks to Be Happy, and I’m not Crazy A person who used to spend a lot of time doing balance transfers and other such games to maximize every penny of interest realizes that it’s a losing game – you’re not making much for the time invested unless you have a HUGE bankroll – in which case, this isn’t the game you should be in. (@ money ning)

Outwardly Simple and Inwardly Rich How rich is your internal life? Many people focus on the wealth present in their external lives – their money, their career, their stuff, and so on – but it’s your internal wealth that you’re left with when you go to sleep at night. Why not focus on maximizing that internal wealth instead of always focusing on the bucks? (@ millionaire money next door)

12 Tricks for Optimizing Your Freelance Career Here’s the thing: we’re ALL freelancers today. This is great advice for ANYONE who is doing creative work, whether they’re employed or not. You’ve GOT to get yourself out there or else you’ll find it much more difficult to move on when your situation changes. (@ freelance switch)

How to Make a Decision Like Ben Franklin This is a VERY good way to make a difficult decision. Almost always, with a difficult decision, it pays to face it head-on with a clear decision-making process. This one, inspired heavily by Benjamin Franklin’s writing on the idea, is pretty close to the one I already use. (@ art of manliness)

Why the stock market is still unsafe for the small investor A great essay on the dangers of stock investing for the small investor by Eliot Spitzer. I still maintain that the only real solution for a small non-obsessed investor is a broadly based index fund with low costs. Anything else is a fool’s game, in my opinion. (@ slate)

My Grandmothers and the Cost of a Funeral The last thing I want to do is burden my descendants with the cost of a funeral. I don’t want to make them have to pay to put me in the ground. Is that an argument for life insurance? I think it is when you’re young, but if you’re older and have a healthy net worth, I don’t see the purpose. The whole thought process pushes me further down the road towards term life insurance. (@ consumerism commentary)

Timebanking: What Is It? Timebanking basically means giving an hour of your own time in exchange for someone else’s hour. Here’s how it works – you visit a local time bank and take on a task that someone has listed – let’s say it’s three hours of painting. You go do that, then you get three hours of credit to use on the site. You can then use that credit to post a job that you want done – three hours of, say, garden work. This seems like a good idea on one level, but you have to find people that are willing to say one hour of their specific type of work is worth an hour of another type of work. (@ christian pf)

Odds Are for Suckers Whenever you try to do something exceptional, the odds are against you. If you let yourself be controlled by those odds, you’ve already decided not to succeed. Instead, ignore the odds. I agree wholeheartedly with the idea here – as long as you have a safety net when you fall, the odds of success should be the furthest thing from your mind. Instead, chase the dream. (@ awake at the wheel)

Uncluttering your personal time Time attracts clutter just as much as space does. In each case, it’s really the same problem – you find yourself gradually filling your time and space with things that are unimportant to you. To declutter, start cutting out the things that are unimportant! It takes some time and reflection, but the rewards are tremendous. (@ unclutterer)

Harnessing Your Competitve Spirit to Spur Your Goals Many people thrive on competition and a desire of “beating” other people. Pick the Brain offers some great advice on how to channel the need for competition into achieving one’s personal goals. I know that in my own life, this works well – I use Nike+ to “keep score” on my goals for getting into shape, for example. (@ pick the brain)

In April and May, National Public Radio featured a series on inexpensive gourmet dishes entitled “How Low Can You Go?” Although many of the dishes looked quite tasty, most of the dishes weren’t actually all that inexpensive, often narrowly getting below $10 to feed a family of four, and many involved arduous cooking processes. I decided to try out some of these recipes throughout the summer to see how I could take the recipes and reduce them down to a simple and very inexpensive form.

Sarah and I were looking for a very simple “How Low Can You Go” recipe that we could actually use for a picnic at the park. It had to be quite simple, something that could be mostly prepared at home with only minimal prep at the park, and it had to be easy to transport.

We were intrigued by the flavor in Kenzie Crosley’s vegetarian burrito bowl submission to the “How Low Can You Go” contest, but we didn’t want to use the amount of prepared food suggested. Here’s Kenzie’s recipe:

1 box Archer Farms(find at Target) Cilantro and Lime Rice
2 Cans Black Beans
Guacamole
Sour Cream
black olives
Queso (Rotel and Velveeta)

Prepare rice as directed on box. Boil black beans in a small pot. Melt 1 can rotel and velveeta in a small dish in the microwave. If family of 4, bring 4 bowls out to serve individually and lawyer as follows. Rice at the bottom, black beans, queso, quacomole, sour cream, olives on top.

These are all things I love-so I just threw them all together for a yummy and easy meal for my husband and I. We have lots of leftovers!

Velveeta? An Archer Farms boxed meal? Hmm… why don’t we just do it from scratch? So that’s what we did.

Here are our ingredients:

Our guacamole spice packet is just a mix of various herbs that’s really tasty and pretty much everything else is from base ingredients.

You’ll notice no black beans are present – that’s because we boiled up some dried beans:

The guacamole was simple to make. Simply peel and core the avocado, then add some spices – salt, a bit of black pepper, garlic, cumin, and/or cilantro. We just used a packet that had this stuff already in it that we had in the cupboard:

Since our daughter is a little iron-deficient, we chose to add a little bit of ground beef that we had in the refrigerator to give her a little extra iron. Not a requirement at all, just something we keep an eye on.

Anyway, we packed up everything into two reusable bags, with reusable bowls and containers:

Once there, we assembled the bowls. Here’s Sarah (who handled most of the prep work for this meal), scooping beans into each of four bowls:

And here’s my finished bowl, enjoyed with a bottle of Dos Equis XX:

The best part about a picnic at the park is that it can immediately be followed by fun on the playground equipment.

Everyone loved it. The bowls were devoured with only a bit of leftovers. It helps that my children love black olives, which made the overall meal seem better than it otherwise would have been.

Our cost for this was about $9, without many leftovers. All we wound up with was leftover black beans, which we intended to use in another recipe later on. So, the cost per bowl was about $2.25 – a little high, but it was very easy to prepare, pretty healthy (aside from the sour cream), and portable enough that it could be eaten at a park.

Changes I Would Make
Obviously, we weren’t strong fans of the prepackaged original meal, so we modified it big time. Here’s what we did instead, which turned out really well.

Trent’s Vegetarian Burrito Bowls

1 cup dry black beans
1 1/2 cups dry rice
1/2 cup lemon juice
1/2 teaspoon cilantro
1 avocado
1/2 teaspoon salt
1 clove garlic, crushed
1/8 teaspoon black pepper
1/2 cup black olives
2 cups shredded Monterey Jack cheese
sour cream to taste

Cook the black beans according to recipe. Cook the rice according to recipe, replacing half a cup of water with half a cup of lime juice and the cilantro. Cut up the avocado, add the salt, garlic, and black pepper, and blend into a paste to make guacamole. Assemble the bowls, starting with rice, then beans, then cheese, then guacamole, then sour cream, then black olives on top. Enjoy!

This is the tenth of twelve parts of a “book club” reading and discussion of Dave Ramsey’s The Total Money Makeover, where this book on debt reduction is teased apart and looked at in detail. This entry covers the eleventh chapter, finishing on page 202. The next entry, covering the twelfth chapter, will appear on Wednesday.

This is a stage that I see us approaching as time goes on. We’re not quite there yet, but we’re close. Right now, I’m trying to knock out my final student loan (it’s a doozy), and then start focusing on my home mortgage.

Our home mortgage payment is just shy of $1,100 – that doesn’t include homeowners’ insurance and taxes, so when we get the house paid off, we now have $1,100 more a month to spend on whatever we choose.

I, for one, would roll that extra amount directly into savings. I’d simply change the automatic payment to be an automatic transfer into a savings account of some sort – perhaps an index fund. Then I just keep living life as normal until one day that account is full of cash for something great. For us, that “something great” is our long-dreamed-of house in the country, with a small barn out back, a big garden, and a chicken coop.

Is It A Crazy Goal?
My parents recently finished off their home mortgage after paying on it for thirty years. They’re pretty much debt free at this point for the first time in their marriage. So, for me, I have a great example in front of me that you can get rid of all of your debt. However, many people don’t have that example and it seems like an impossible goal. On page 186:

Anytime I speak about paying off mortgages, people give me that special look. They think I’m crazy for two reasons. One, most people have lost their hope, and they don’t really believe there is any chance for them. Two, most people believe all the mortgage myths that have been spread.

The “hope” factor is something I see popping up over and over again whenever I talk to people about money. Many people I talk to view their mortgage as simply a fact of life. If they were ever in a position that their mortgage became really easy to pay, it wouldn’t be time to double-up on the payments – no, no, it would be time to upgrade their homes.

I think this points to a prevalent mindset out there when it comes to debt. Many people simply view debt as a way to leverage the lifestyle they want now. It comes from a lack of patience – people don’t want to live in a small apartment watching their savings grow slowly when they could just get this loan and be in that house now – even if it costs them hundreds of thousands of dollars.

I think patience is one of the biggest tools a young professional can have when it comes to his/her money. Just wait for a while – you’ll be way better off over the long run.

The Tax Deduction Myth
Owning a mortgage just to get a tax deduction is something of a fool’s game, as outlined on page 187:

If you have a home with a payment of around $900, and the interest portion is $830 per month, you have paid around $10,000 in interest that year, which creates a tax deduction. If, instead, you have a debt-free home, you would, in fact, lose the tax deduction, so they myth says to keep your home mortgaged because of tax advantages. [...] If you do not have a $10,000 tax deduction and you are in a 30 percent tax bracket, you will have to pay $3,000 in taxes [...] According to the myth, we should send $10,000 in interest to the bank so that we don’t have to send $3,000 in taxes to the IRS.

All the tax deduction does is lower the effective interest rate you’re paying on your home loan a little bit.

In fact, Dave doesn’t even make the case as well as he could. If you’re using your mortgage interest on your tax return, that means you’re foregoing your standard deductions because you have other things to deduct. So, take our situation – we have two adults in our home. Our standard deduction in 2009 is $11,400. If we choose to itemize our taxes (which we’d have to do to deduct our home interest), we have to have more than $11,400 in interest on our home mortgage (or other deductible expenses) to beat what we would already get.

So, if your only significant deductible expense is your home mortgage – and your mortgage isn’t gigantic – you’re not actually gaining much of anything at all in terms of taxes.

The Risk of Having a Mortgage
Another disadvantage of holding on to a mortgage is the risk – if something goes wrong in your life, it’s a lot better to not have a mortgage payment than it is to have one. On page 189:

If I own the home next to you and have no debt, and you (because of your investment adviser guy) borrowed $100,000 on your home, who has taken more risk? When the economy moves south, when there is war or rumors of war, when you get sick or have a car wreck or are downsized, you will run into major problems with a $100,000 mortgage that I will never have. So debt causes risk to increase.

I think this is a vital, overlooked point. Having a mortgage – or any debt – is a type of risk. You’re gambling that your future will be stable, no different than putting cash down at the roulette wheel. With a mortgage, your life is simply more at risk than it was before.

I have two young children at home. Risk stares me in the face every day. I encourage our children to push their limits a little, but I still stand very close by when my three year old grabs onto playground gymnastics rings and hangs there. Having a mortgage is something like telling my three year old to grab the rings for the first time while I stand far away. Sure, he might hold the rings for a while and then drop without a problem, but my distance increases the chance of a hurt elbow or a broken arm.

The risk of owning a fat mortgage is much like the risk of putting your child on a bike for the first time and shoving them down the sidewalk. Sure, they might ride like the wind, but they might also fall flat on the pavement. Instead, it’s better to do a bit of planning (like saving for a home) and then let go when they’re ready (like when you have enough saved up for a house). No broken bones, no broken lives.

Thirty Years Versus Fifteen Years
Many people advised me to get a thirty year mortgage instead of a fifteen year mortgage, arguing that I could make an extra payment each month and get the same speed benefit of a fifteen year without the risk of the larger minimum payments. That’s a bad idea because something will often come up, as is spelled out on page 190:

A big part of being strong financially is that you know where you are weak and take action to make sure you don’t fall prey to the weakness. And we ALL are weak. Sick children, bad transmissions, prom dresses, high heat bills, and dog vaccinations come up, and you won’t make the extra payment. Then we extend the lie by saying, “Oh, I will next month.”

A higher minimum payment is actually a good idea, because it forces us to work with what we have left over. A lower minimum payment means that we just have more to work with – if that extra payment isn’t required, it’s easier to argue that something else is more important for the moment.

With expenses like prom dresses, heat bills, bad transmissions, and dog vaccinations, you can always find ways to make it work. If you have a decent emergency fund, it shouldn’t be too tough at all.

What do you get in exchange for these little sacrifices? Your mortgage goes away in half the time. You find yourself free of that load much, much faster. Plus, the interest rate on a fifteen year loan is lower, meaning your payments won’t actually be anywhere close to double what they would be for a thirty year mortgage.

Home Equity Loans Make Poor Emergency Funds
One common question I get from readers is whether or not they should take out a home equity loan to deal with some problem in their lives. My feeling is that if you’re in that situation, you need to rethink about your emergency fund. Sure, the home equity loan might be the right solution for right now, but if you’re living your life in such a way that it has to be used, you might want to rethink how you’re managing your money.

On page 197, Dave dips his toes into this idea:

Even a conservative person who doesn’t have credit card debt and pays cash for vacations can make the mistake of the HEL by setting up a loan or a “line of credit” just for emergencies. That seems reasonable until you have walked through an emergency or two, and you realize very plainly that an emergency is the last time you need to be borrowing money. If you have a car wreck or lose your job and then borrow $30,000 against your home to live in while you make a comeback, you will likely lose your home. Most HELs are renewable annually, meaning they requalify you for the loan once a year.

Think of it this way. You’re using your home equity loan as an emergency fund. You lose your job, so you take out $30,000 to live on – it’s fine, since you have tons of equity in your home, right? Well, the end of the year comes and you still don’t have a job. The bank says, “Sorry, we’re not renewing your loan,” and they call in the $30,000. You don’t have it. They repossess your house. Any equity you built up is gone.

An emergency fund needs to be cash, period. If it’s not liquid or it puts you at risk to get it, then it’s not an emergency fund.

Our local credit union has hinted to us that we should have a home equity line of credit. I have torn up every single offer they have sent to us. I’m not interested in that kind of risk.

Paying Cash for a Home Is Impossible
I agree with Dave that it is indeed possible to pay for your home with cash. So why don’t people ever do it? It’s not easy. It’s a lot harder to go this way than it is to just go get a mortgage. On page 198:

Paying cash for a home is possible, very possible. What’s hard to find is people willing to pay the price in sacrificed lifestyle.

I think the problem is that many people view their home as more than just living quarters. They view it as a status symbol – they need a house they can show off to family and friends. It’s more impressive to live in a house than an apartment, isn’t it? So, if you back up and think about it, you pay hundreds of thousands of dollars in interest, home maintenance, and other costs – not to mention time – in order to impress others.

Again, the only people impressed with such things are people that you never speak to, who don’t matter in your life. They look at you and admire your home, but they don’t build a relationship with you. The people you build lasting relationships with like you, not your house.

We chose to buy a home with a mortgage. I don’t regret it, but if I had to do it all over again, I would have looked intensely for a great rental situation instead (since we originally lived in an apartment too small for two toddlers and two adults – we had to move) and kept saving.

Do you have any other thoughts on this chapter of The Total Money Makeover? Please share them in the comments – and feel free to respond to any of my impressions as well. After all, a good book club is all about discussion!

On Wednesday, we’ll tackle the twelfth chapter – Build Wealth Like Crazy.

This is the seventh of twelve parts of a “book club” reading and discussion of Dave Ramsey’s The Total Money Makeover, where this book on debt reduction is teased apart and looked at in detail. This entry covers the eighth chapter, finishing on page 150. The next entry, covering the ninth chapter, will appear on Saturday.

I’m a big believer in the unpredictability of life (in fact, this unpredictability is a major theme in my upcoming book). Life deals you things you don’t expect all the time, from small (like an unexpected wet diaper on your way out the door) to big (a sudden death of a close relative) and from good (finding a $100 bill in a parking lot) to bad (breaking your big toe after dropping something heavy on it).

Yet, even given that hugely unpredictable nature in life, most people do not have an emergency fund. Many of those who do only have a tiny fund. What happens to them if they lose their job and can’t get another one for a year? What happens if their child is invited to go to a very prestigious music school? What happens if one of them falls down a flight of stairs and has to spend six months in a wheelchair?

The solution to all of these things is a big, fat emergency fund. A big healthy wad of cash in the bank makes all of these problems easily bearable. For Ramsey, this is the next step after your debt snowball is done and all you’re left with is a mortgage – get a big chunk of change in the bank for those rainy days.

How Big?
One big point of contention about emergency funds is how big they should be. Dave offers his opinion on page 133:

A fully funded emergency fund covers three to six months of expense. What would it take for you to live three to six months if you lost your income?

I think it’s key here to point out that by “you,” the quote most likely refers to the full spending of a household – if it doesn’t, then you might be building an emergency fund that’s too small.

Three to six months? Think about how much you spend each month, then multiply that by, say, five. That’s quite a serious chunk of change. For us, it would probably be somewhere in the ballpark of $20,000, with almost half of that being our mortgage and homeowners’ insurance.

Is it enough? I think you have to look at it from the perspective that no amount will cover every possibility that could happen. Instead, you should be seeking an amount that’s large enough to cover every doomsday scenario you can reasonably think of. Consider the people around you and their most desperate moments. How much would they have needed in those situations?

Easy to Access
Dave basically argues for a savings account on page 137:

Keep your emergency fund in something that is liquid. Liquid is a money term that means easy to get into with no penalties. If you would hesitate to use the fund because of the penalties you’ll incur to get it, you have it in the wrong place.

That basically means a savings account. It’s accessible at any time without penalty and it doesn’t fluctuate in value.

Obviously, you want it to be as safe as possible. This eliminates stocks – they’re inherently risky and fluctuate too much. The value of bonds can fluctuate, too, though not nearly as strongly. You don’t want to lose your balance once it’s invested.

At the same time, you want to be able to get at it without a penalty of any kind. Dave argues that this is a black mark against certificates of deposits. I disagree with that. With some careful planning, you can use certificates of deposit in a “ladder” system and never have to crack one. I like this idea because it helps you get a better rate of return and it’s a psychological barrier that keeps you from digging into it.

Dave points towards money market accounts, another little hint that this book was written prior to 2008. Money market accounts might have great returns sometimes, but they’re not as safe as FDIC-insured savings account. Even better, if you hunt around, you can find FDIC-insured savings accounts that have a nicer return than pretty much any money market account and come with the insurance.

Three Months? Six Months? In the Middle?
The entire point of an emergency fund is to absorb risk, and some families are simply more at risk than others. On page 139:

For example, if you earn straight commission or are self-employed, you should use the six months rule. If you are single or you are a one-income married household, you should use the six-month rule because a job loss in your situation is a 100 percent cut in household income. If your job situation is unstable or there are chronic medical problems in the family, you, too, should lean toward the six month rule.

Personally, I feel as though children are a significant risk addition to one’s life. An adult can go out there and get a job. A three year old can’t do the same – they’re wholly dependent on the adult. Thus, if you have kids, I’d lean strongly towards a bigger fund.

I also think that six months isn’t necessarily the maximum. If all of your household income comes from freelancing, you have three kids, and there may be health issues in your future, six months probably isn’t enough. I’d have more than that – a year’s worth, perhaps?

We have about ten months’ worth of purely liquid cash sitting there for emergency purposes right now. That’s an amount that feels right for us, with the majority of our household income coming from freelancing and two children under the age of four.

Is Everybody on Board?
One issue I see readers writing to me about time and time again is the question of what to do when their partner isn’t on board with the financial changes they want to make. Dave hits on this a bit on page 142:

I don’t suggest you clean out your savings [down to $1,000 in order to pay off debt] if everyone isn’t having a Total Money Makeover.

I go further than that: if you’re in a relationship and your partner is not on board with making financial change, you’re wasting your time with it. Their actions will undermine everything you do and you’ll find yourself constantly at odds and angry with each other without making a drop of additional progress. That’s a dangerous recipe, right there.

If your partner is not on board with making some real financial changes, your focus shouldn’t be on charging full steam ahead without your partner. Instead, your focus should be on talking through your situation with your partner. You’ve got to understand where they’re coming from. Just pushing what you want won’t cut the mustard here – they’ll just see you as pushy and you’ll make negative progress, or you’ll get an act that makes it look like they’re on board when they’re really not.

Talk about your money. You’ve got to, or none of this will work.

Women and Men?
Are women more suited to have emergency funds than men? On page 144:

God wired ladies better on this subject than He did us. Their nature causes them to gravitate toward the emergency fund. Somewhere down inside the typical lady is a “security gland,” and when financial stress enters the scene, that gland will spasm.

The argument here is that by their very nature, women are more likely to see the value in an emergency fund than men. Men tend to be task-oriented, while women tend to be process- and security-oriented.

I think there’s actually something to this. I’m all in favor of gender equality, but different does not mean unequal. Different means that each side has traits that are beneficial. Guys are better at focusing in, at breaking down barriers. Women are better at planning and cooperation, at building fortresses of safety. Different attitudes are useful in different situations.

I see this in my own marriage. I’m far better with specific objectives with my children. I thrive on having a series of tasks to do or a game to play or something like that. My wife, on the other hand, seems to thrive more on nurturing. She holds them and is patient when they’re hurt, where I’m much more likely to look for how to solve the problem. When Joe bumps his knee, my wife is more likely to hold him while I go searching for a Band-Aid.

The emergency fund is definitely in her court, not mine. I see the value of it and I contribute to it, but it’s clearly more a part of her elemental nature.

Why Do All This?
If the future is so unpredictable, why waste our lives right now putting so much effort into scrimping and saving and planning for that future? On page 146:

What used to be a huge, life-altering event will become a mere inconvenience. When you are debt-free and aggressively investing to become wealthy, taking a few months off from investing will put a new engine in a car. When I say the emergency fund is Murphy-repellent, that is only partially correct. The reality is that Murphy doesn’t visit as much, but when he does we hardly notice his presence.

A big emergency fund means that the bad events in that unpredictable future don’t wipe away all of the good things you have in your life.

Without an emergency fund, a job loss means panic. It means scrambling madly for work – any work. It means you might lose your home or your car. It’s scary.

With an emergency fund, you can roll with the punches. You can patiently dig for the right job. You can even give your dreams of freelancing a shot right now – after all, you’ve got time.

Without an emergency fund, a dead car means panic. It means you have to throw yourself further in debt, with even more monthly payments than before.

With an emergency fund, you just make the call and fix the problem. No big debts. No monthly payments. Just smooth sailing.

You’re left with unexpected events – but only the good kind.

Do you have any other thoughts on this chapter of The Total Money Makeover? Please share them in the comments – and feel free to respond to any of my impressions as well. After all, a good book club is all about discussion!

On Saturday, we’ll tackle the ninth chapter – Maximize Retirement Investing.