If you're maxed out on your credit cards and withdrawing from savings to pay regular bills, it's time to break bad habits and start budgeting-planning to pay off old debts and ease the impact of new ones.
You don't have to be financially savvy to put a budget together. All it takes is some organization, the ability to do simple arithmetic, and the discipline to record, and limit, your expenditures.
Here are the steps to building a budget:
First-Start with fixed monthly costs, such as mortgage or rent payment, and regular installment loan payments, such as the car.
Second-Record how much you anticipate spending each month on other necessary expenses that vary in amount, including credit-card payments, utilities, food, insurance, and household supplies.
Third-Include a category for savings, such as a 401(k) at work, certificates of deposit, or a mutual fund. If possible, put aside 10 percent of your net income. But if you are paying high interest, it makes better sense to pay off these debts first.
Fourth-Don't forget discretionary items, such as charitable contributions, entertainment, clothing, home improvements, and vacations.
Fifth-Establish a "rainy day" fund equal to three to six months of after-tax income. With this money in reserve, you won't have to scramble as much when that rainy day reveals a hole in the roof.
Other things to consider-The amount of your debt, as well as your savings goals, will affect how much you budget for entertainment.
You may find that there's less for the dining out and vacation category because of the need to pay off debts or meet a savings objective. However, you should always have money in your budget for activities that you and your family enjoy. If your budget isn't realistic, you'll never be able to stick to it.
While working on the budget, plan short- , intermediate- , and long-term goals. Are you in an apartment, but want to buy a house? Planning to have a baby or buy a new car?
And lastly, don't underestimate the effects of inflation. This is especially true if you are planning to save for retirement or send a child to college.
While inflation today is running at only about 1 percent, it has averaged 3 percent this decade, and 5 percent annually over the past 20 years. Even at 3 percent, the value of the dollar would be cut in half in 25 years.
How to slay the debt dragon
Good debt is for something that lasts longer than the loan, such as houses, education, and cars. Bad debt is for items you can't afford to repay over a reasonable time. Here are guidelines for managing debt:
· Small purchases, under $500: Pay cash if possible, or use a debit card, which takes cash from your bank account as it's spent. Put small purchases on a credit card only if you know you'll pay off the monthly bill in full.
· Medium purchases, $500 to $2,000: If you've been disciplined enough to put together a "rainy day" fund, dip into it for medium-sized purchases, such as a new stove, that are truly emergencies. If you don't have the cash set aside, put these items on a low-rate credit card.
· Large purchases, $2,000 to $20,000: Whether you are hit with medical bills or want to consolidate all your credit-card payments into one at a lower rate, there are several options, such as borrowing from your 401(k) at work or from a cash-value life insurance plan.
· Jumbo purchases, over $20,000: If you are borrowing for home renovations or to consolidate debts, a home-equity loan makes the most sense.