When the Emergency is Bigger than the Fund

Reader Question:

What should we do when disaster strikes during Baby Step 2? We are a single income household and my husband just lost his job. We have no emergency fund on hand, other than the $1000 from Baby Step #1.  We do have sizable retirement accounts, but are just trying to decide at what point do we tap them and have to pay that 10% penalty, and how much do we take out at that time? The regular savings accounts disappeared when the kids started college and we have been playing catch-up ever since.

The worst thing you can do when faced with a job loss is to continue to live on the ghost of yesterday’s income. Supplementing your phantom paychecks with credit cards or your retirement savings might make you feel better today, but it will only extend your financial pain.

When your income situation has changed for the worse, whether due to job loss, hours cut or a reduction in bonus – QUIT! Quit your old lifestyle – Today! Do not eat up savings or take on debt to maintain a lifestyle you can no longer afford.

Start by creating a crisis budget. Income is your unemployment + any other.

Just knowing exactly where you are will relieve stress. Having a plan will help you avoid emotionally driven mistakes.

Prioritize the expenses. Feed the family first, then utilities, then pay your rent or mortgage and secure your transportation. Let credit cards and student loans sit if need be.

Start the plan with basic food, no restaurants, no fast food, no steaks, no beer, just beans & rice, Mac & Cheese, PB&J; cut the budget to the bone.

Next, list the utilities, water, electric, gas, NOT cable – NOT internet. If the utilities are behind catch them up before doing anything else.

Shelter is our next priority. List the rent or mortgage.

Finally, secure transportation. List the car payment, get a bus pass, and set gas money aside.

Draw your first line on your budget when you have fulfilled these obligations. Don’t cheat – only include the most very basic Four Walls (food, utilities, shelter, transportation) expenses.

What if your income doesn’t stretch this far?

First go back and check again, are you sure you have each of the categories as low as you can go? If you cannot meet your four walls’ obligations, we may need more drastic action.

Sell your car and get a cheaper one with no payments.

Find a cheaper place to live, or get a roommate.

Get some Income – Quick!

Any income helps.  Everyone in the house over the age of 12 needs to get to work and once they have a job, they need to add a second job. Cobble together several part time jobs, do some babysitting, housecleaning or sell some stuff.

Now, prioritize the rest of your expenses; you need health, life, auto and homeowners insurance. You would like to keep the internet, the cell phones and pay the kids tuition.

Draw your second line when you have, on paper, spent all the income available. Everything below the second line is going to have to wait.

Don’t Panic

Retirement accounts should only be cashed in to avoid bankruptcy or foreclosure and you must be very, very careful even then. Not only will you pay the 10% on the withdrawal, you will be liable for the taxes on that previously untaxed income as well.

Breathe, take care of your relationships, accept help and understand that this is a temporary situation.

Should I Refinance?

Here’s the quick answer.

If you can reduce your interest rate by 2%, will stay in the house at least 3 years and can decrease the term or at least not lengthen it, the answer is most probably YES.

A fixed rate mortgage with a term of no more than 15 years is your best bet. With interest rates currently so low, those with adjustable rate mortgages should be checking into refinancing to a fixed rate loan even if the rate is higher. Do not fool yourself by taking out a 30-year loan with the intention of paying it like a 15. Many people have said they were going to do that and 97.3% fail.

One loud word of caution, DO NOT roll credit card or car loans into your re-finance. See Bad Dog for more on that subject.

Let us look at real life example:

Our perfect family last refinanced their home in 2002 taking out a $150,000, 30 year 5.865% mortgage to do some needed home repairs. They plan to stay in their home when they retire in 11 years, but the current job market makes them worry they might have to relocate. Our happy family has at least 20% equity in their home and good credit. If they didn’t, that would change things. It might require them to purchase PMI or pay down the balance or it might make them ineligible for refinance.

To get the real (not the advertised) current mortgage interest rates, head over to Freddie Mac and click on the Regional Breakdown to see rates and Fee & Points. This shows us in the Southeast the actual average locked in rate last week was 3.68% on a 15-year mortgage with fees and points of .8%.

Use a mortgage calculator with amortization schedule like this one to find the interest paid each month, run a full schedule on the existing loan as well as the proposed loan.

We can use this information to compare the difference between keeping the existing loan and refinancing. For this comparison, we used the payoff amount of the existing loan + $1600 for fees and costs as the beginning principal amount for the new loan.

Rate Term Payment Total Payments Interest
Current Loan 5.865 21 years remaining $              886.35 $           223,360.20 $                  95,088.63
Re-Fi 3.68 15 years $              939.95 $           169,191.00 $                  39,319.56
Difference 2.185 6 years $              (53.60) $             54,169.20 $                  55,769.07

Reducing the interest by over 2 points and shortening the term by 6 years increases the monthly payment by $54. However, by the time the home is paid for (15 years on the new or 21 on the old) the new loan will save our family 55K in interest expense.

What if they have to move? In this example, the $1600 for points and fees is recovered within 7 months so if they manage to stay that long they will break even.

The real gift in re-financing this loan is the 6 year reduction in term. If our couple can find a way to pay $54 more a month now, later they can skip 72 monthly payments of $886.35.

Sinking Funds to the Rescue

Things seem to be going according to your budget when along comes the bill for your homeowner’s insurance or the kids checkups or new tires and in one transaction your carefully conceived budget is blown. These expected but irregular expenses can be difficult to handle unless you do a little advance planning.

A well-managed sinking fund is an often forgotten but crucial component of your financial plan.

In our household, nearly 40% of our expenses are non-monthly. Insurance and taxes are reasonably predictable but we pay them quarterly or annually. Car repair and medical bills are unpredictable in both the amount and frequency. We also use our sinking fund for luxury items like vacations, gifts and home improvements where we have the flexibility to set the amount and the due date ourselves.

Here’s how we manage our sinking fund:

We have a spreadsheet listing each non-monthly expense its due date and a predicted amount due. Divide the amount due by the number of months until the due date to find out how much your monthly contribution needs to be.

Sinking Funds

Each month when we lay out our budget, the necessary monthly amount for each of our sinking funds goes in the second column of our budget form while expenses that we pay this month go in the first column.

For example, in the category, Housing, property taxes, repairs and insurance are all sinking fund accounts while pool supplies and propane are regular monthly expenses. The green background notates that Property Taxes and Insurance have required fixed amounts while we do have some flexibility on what we contribute to Repairs & Upkeep.

We complete the budget for the month making sure we allocate all income. Income can pay expenses, pay debt, go toward retirement saving, emergency fund saving, sinking fund saving or investment, but we must plan in advance what to do with all of it.

When we are done with the budget, it looks like this:

Income Current Month Sinking Funds
Net Monthly Income $3,498.00
Giving $200.00
Housing $-
Saving Property Taxes $267.00
Saving Homeowners Insurance $292.00
Repairs/Upkeep $75.00
Pool& Propane $75.00
Electricity $250.00
Internet Business
Cell Phone $68.00
Trash (Dec, March, June, Sept) $32.00
Water/Sewer (Dec, March, June, Sept) $80.00
Groceries/Household $700.00
Eating Out $150.00
Gas $220.00
Repairs, Oil, Tires $45.00
Car Tags/Registration $12.50
Car Insurance $143.00
Bike Parts
Personal Care
Hair Care
Dental/Vision/Medical $100.00
Pet Care – Food/Meds/Vet $15.00
Life Insurance $34.00
Disability Insurance $166.67
Health Insurance $173.00
Boat Insurance $23.00
Netflix, MLB, Hulu $31.58
Blow Money $100.00
Other Entertainment $145.25
Vacation $50.00
Gifts $50.00
TOTAL Expense $2,224.83 $1,273.17

The monthly total for sinking funds is transferred to our high interest checking account.


Sinking Fund Months till due Date Due Amount Due Monthly Balance Spent New Balance
Budget for 6/1/2011
Property Taxes 6 11/29/2011 3,700.00 267.00 2,115.80 2,382.80
Homeowners Insurance 9 3/4/2012 3,795.00 292.00 1,137.80 1,429.80
Home Repairs/Upkeep as needed 75.00 5,556.76 5,631.76
Repairs, Oil, Tires, Car replacement as needed 45.00 5,892.76 5,937.76
Car Tags/Registration 9 3/1/2012 150.00 12.50 37.50 50.00
Car Insurance 3 9/1/2011 860.00 143.33 430.01 573.34
Dental/Vision/Medical as needed 100.00 3,676.97 3,776.97
Pet Care – Grooming/Meds/Vet as needed 15.00 116.46 131.46
Life Insurance 1 7/1/2011 827.00 34.00 793.00 827.00
Disability Insurance 2 8/11/2011 552.00 166.67 163.10 329.77
Boat Insurance 6 12/1/2011 529.00 23.00 391.00 414.00
Vacation as desired 50.00 50.00 50.00
Gifts as needed 50.00 968.00 1,018.00
TOTAL Sinking Funds 1,273.50 21,329.16 22,502.66

Any planned or necessary sinking fund expense is then paid out of that account and deducted from the correct category to give us our new balance for the next month.

Everyone needs a sinking fund. Even if you are still paying off debt, you must account for irregular expenses. The car needing tires is not an emergency. With experience, you can learn to predict what car and household repairs to expect and about how much they will cost.

If you are just starting out, there may be times when there is not enough money in your sinking fund to cover a necessary expense. Now what?  If the starter is out on the car and you need the car to get to work this may be an emergency. Dip into the emergency fund to take care of the problem and then make rebuilding that emergency fund your top priority.

Borrowing between sinking funds is allowable in my house as long as:

1) The account  to be borrowed from is not one setup to pay a required expense with a definite due date.

2) We both agree.

A well managed sinking fund protects your emergency fund and makes large expenses much more manageable.

Break through thinking, if you don’t need it, don’t buy it.

When I first started playing with this “get out of debt” thing, I did it quietly for two months. I cut out mindless spending, cut way back on eating out, changed a couple of insurance policies, cancelled some subscriptions and paid off my truck.

One of my mindless spending habits was Target. For the longest time, I would take my Mom to Target on Sunday afternoons. We could get things she needed while I was around to help load and carry them. The habit was an easy way to be sure I spent time with her every week because my job kept me so stupidly busy Monday through Friday.

What did I buy? I wish I could tell you. I know I spent about $100 every Sunday. I know I rarely had a list of things I needed. It was shopping for entertainment and I don’t even like to shop. One thing I remember that I bought every week was a big busy bone for Higgins. It cost about $6. If I did that every week for a year, that was $312!

Some of that $100 was for things I needed; paper towels, toilet paper, cleaning stuff; but most of it was impulse buys. Looking at what I spend now, I estimate that 25% of the $100 average weekly trip went to necessities. Eliminating Target mindless spending allowed me to put $7800 over the course of 24 months towards killing debt.

If you are just getting started on this thing, before you take your next trip to Target or Wal-Mart or wherever, take everything out of the cupboard where you keep cleaning supplies and inventory it. How many cans of Pledge, bottles of Febreze or boxes of Swiffer refills do you need? Don’t buy any new products until you’ve used up the old.

When we replaced our windows years ago, the installer recommended cleaning them with a mixture of 10% cheap white vinegar, 90% water with a bit of Dawn detergent – if they are really dirty. This same concoction works great on our bathrooms and counters and floors (just not marble). One spray bottle: cheap, easy, and effective.

Do the same for your pantry. Is there really a need for 4 jars of peanut butter? Take everything out; inventory it and figure out how to use it up.

So, what about getting together with Mom? Our regular outing is now to the library. We still go to Target occasionally, but if there is nothing on my list, I don’t buy anything. And as for Higgins, he is glad to have a walk instead of a bone, any day.

How Much Money Would it Take?

I have a great “get out of debt” story, but I am sometimes reluctant to share the details. When we decided to do this thing, we really did it. Without selling anything significant or inheriting anything or winning the lotto, we paid off $220,000 in debt in just 24 months.

During that period, we had a significant income. I had a great paying job, we had several side hustles and Jim had retirement income.

My reluctance to share the numbers of our story stems from a fear that some will use this as another reason that they can’t win, instead of inspiration that they can. If you hear this and think, if only I made that kind of money I would be debt free and fiscally fit too. Please read on.

People with huge incomes lose all the time, maybe even in similar percentages to those with lesser incomes.

Take for example, NFL players, the minimum salary in 2011 is something like $340K a year yet many of them are considering taking out high fee, high interest loans to get the through the lockout. (Excellent post on the subject, NFL Players, Lockout Loans, and Predatory Lending by Lazy Man and Money). This is despite the fact that the Players Association will pay them $60K over a six-week lockout.

Dang, at least $340K a year and they don’t have any savings to get them through a rough patch even after a $60K payday?  What kind of fools are these guys?

Wait a second, they are the same kind of fool that I was. They spend all, or most of, or more than they make. They build no safety net into their finances. Banks have offered them easy money to buy the glittery stuff that their peers were wearing or driving and they took this to mean they could afford it.

The key principal of financial success is the same whether you make $35K or $340K .

Spend less than you make.

If you need to dump debt – spend significantly less then you make.

If you are like me and you really, really NEED in your heart to be free, find a way to live on the smallest possible percentage of your income.

Mine was 21%.


You are a self-sabotaging, irrational but often altruistic toad – however I say that with love in my heart. It’s not just me who thinks so; turns out there is a whole science devoted to the “how and why” we make the choices we do. Guess what they discovered – we are all hopelessly irrational.

Behavioral Economics is a rather young science that merges economics with psychology in order to study how real people make choices. When making decisions, we would think people choose the option that maximizes profits and benefits to themselves, right?

Let’s think about it. Are the decisions you make about your money, your health or your future rational?

Have you quit smoking or paid off your debt? Do you exercise and eat right? Are you saving enough for retirement? In short, are you doing the things that you know will lead to your goals?

Smart people behave irrationally (so do dumb people).  It is a scientifically proven fact that we knowingly make decisions in direct conflict with what we want to happen. In addition to choosing poorly, we often sabotage our futures by refusing to choose.

David Laibson, Professor of Economics at Harvard writes; “There’s a fundamental tension, in humans and other animals, between seizing available rewards in the present, and being patient for rewards in the future,” he says. “It’s radically important. People very robustly want instant gratification right now, and want to be patient in the future. If you ask people, ‘Which do you want right now, fruit or chocolate?’ they say, ‘Chocolate!’ But if you ask, ‘Which one a week from now?’ they will say, ‘Fruit.’ Now we want chocolate, cigarettes, and a trashy movie. In the future, we want to eat fruit, to quit smoking, and to watch Bergman films.”

I know Laibson is talking about me. I definitely want to eat better and exercise more – later.

When it comes to our money, we buy stuff on credit even though using credit reduces the amount of stuff  we can buy. We walk away from free money in the form of our employer’s match on our 401k and we fail to make a budget or set aside an emergency fund even though we readily agree that these are all things we want to do.

How do we overcome our irrational desires?

I win with my money not because “I’m oh so smart“, but because I’ve finally accepted that guys like Laibson and Ariely are right. To paraphrase Pogo, “I have seen the enemy and she is me”.

Recognizing that the biggest danger to my financial future is my own irrational decision-making, I have set in place a system of pre-commitments that force me to follow through my rational plan.

Here are things I do that will work for you:

  • Make a budget in ADVANCE of the month and sign off on it with your spouse or accountability partner. Hold each other to the commitment.
  • Don’t give yourself easy access to money or credit. Cut up the credit cards or at least hide them. Make your savings harder – not easier to get to.
  • Make savings automatic – have your savings direct deposited or at least moved automatically as soon as it hits your account.
  • Post the Wish List on the fridge – don’t buy things that aren’t on the list even if you have the money.

Want to learn more about Behavior Economics?

Dan Ariely, Professor of Behavioral Economics at Duke has a podcast at ITunes U called Arming the Donkeys. The segments are really short, interesting and easy to understand. Give it a listen.

Break the Chains

Did you inadvertently and unknowingly trade your freedom for a flat screen TV, dinners out and a drawer full of obsolete electronics?

Joe Plemon recently published an excellent blog titled, What is Your Debt Actually Costing You? In addition to the dollar cost, in terms of interest paid, that comes to mind immediately, Joe lists lost opportunity cost, marital costs, health costs and what he calls the creativity costs as components of the actual cost of debt.

Any one of these costs can be devastating to your happiness.

Let’s look more closely at what Joe calls the Creativity Cost of debt.

If your debt load has you stuck in an unhappy, unhealthy job, I’m sure you’ll agree that creativity cost of debt is way too nice of a term to describe what is holding you in your situation. That debt is costing not just your creativity but your freedom as well.

I live in an area of historically low wages and current high unemployment. I have heard from several people that even businesses that have not been hurt by the recession are using the tough job market like a baseball bat to beat up their work force.

Employees find themselves charged a larger percentage of their healthcare costs, given heavier workloads and constantly threatened with pay cuts, reduced hours or unemployment.

Scared by high unemployment rates, dropping wages and mostly by their own precarious financial situation, many remain chained in miserable jobs and suffer day after day.

If you are currently employed by a Simon Legree and feel you cannot leave because of the mountain of debt you owe, you not only understand “the borrower is slave to the lender”, you feel it.

The situation should make you angry. You should be mad that someone would use economic news instead of your companies actual economic reality to influence jobs and wages.

You should also be mad that you allowed yourself to be painted into this very uncomfortable corner.

There is little you can do about your employer’s lack of empathy – but there is a lot you can do about your own vulnerability.

Use this anger to fuel your new financial rebirth; get so mad about your lack of options that you swear to never again go into debt or to be without a big emergency fund.

Remember these feelings of anger and powerlessness and call on them to motivate you to really attack your debt this time.

Together or Separate?

Many couples choose to operate as independent financial entities.  They each have their own checking account, their own credit cards, their own savings and their own debt. These couples normally have come to some understanding of who is responsible for what expenses.

Is this a problem?

If you have chosen to keep finances separate instead of together, you need to ask yourself are you being private or are you trying to deceive? If you keep things separate because your partner would object to some of your spending or savings behaviors, you may be trying to appear to them as someone you’re not. Does that really sound like the basis for a good relationship, to you?

As long as both of you are clear on what you expect from the other financially and neither is trying to deceive, then I don’t think it’s necessarily a problem. However, I strongly believe couples that maintain separate finances are really missing out on an opportunity to deepen their relationship and improve the overall success of the family.

We used to handle our finances separately and it seems many of my friends still do. If the opportunity arises, I am quick to tell them how much merging our finances has improved not only our financial situation but also our relationship. It is very difficult to truly be together if don’t talk about your dreams and aspirations. Being smart about your money all starts with having goals and if you want to really share your life then you need to share your goals.

Putting your money together, forces you to communicate. If you are both writing checks out of the same account and no one is talking, bad things are likely to happen. One place I believe it is helpful to have less disclosure is with the budgeted blow money. Unless a couple is in financial crisis there should be some reasonable amount of money budgeted to each for blow money. In my way of thinking, that amount should be equal. What that money is spent on does not need to be recorded or disclosed. That’s why it’s called blow money. For one partner to question the validity of the blow money purchases of the other, defeats the whole purpose of not having to be accountable for that spending.

I’ve seen separate money behavior deteriorate to the point of having one spouse direct their credit card bills and bank statements to their work address or to a secret post office box. This level of deceit destroys a relationship. If you’ve fallen into this type of behavior and there are debts your spouse is unaware of, now is the time to resolve to change the situation. Seek the help of marriage counselor, financial coach or your pastor and end the secrecy.

The Secret to Getting Out of Debt

I am a “get off your butt and do something” kind of person. I value planning and thinking and strategizing about a problem, but in the end you actually have to do something to see some progress. That’s why I loved this post by frugaldad.

In his article, The Secret to Getting Out of Debt: Forget Snowballs and Interest Rates, frugaldad writes:

“The last two years of my personal journey to debt freedom, something finally clicked. It didn’t matter how I ordered my debts, how many half payments I made, how many times I transferred balances from card to card chasing a lower rate, or how many times I consolidated my credit card balances; the only thing that was going to get me out of debt was boosting my income.”

He goes on to argue that in order to get out of debt you must find more work for a short period of time. Working 70 hours a week and devoting all the money earned from those extra hours is how he got out of debt.

I think he’s on to something here for several reasons:

1)     Simple math

Extra income to pay down debt pays debt down faster

2)     Focus

This should probably be number 1. If you are working when others are relaxing, you must remind yourself of your focus several times a day. I am making this sacrifice because I am getting out of debt. What are the chances you would “forget” your mission and make a non-essential purchase at the mall while working 70 hours a week?

3)     Boredom

If you’re working a side hustle, especially if you can find one that inspires you, there is less chance to spend money out of boredom. This type of spending wrecks budgets all the time.

He goes on to say:

“Debt has a way of trapping you – in bad jobs, in bad relationships, in bad locations. It’s a suffocating financial cancer that eats away at your future dollars, and your current enjoyment. It adds immeasurable risk to your life. It is not to be ignored for another moment.”

Clearly, frugaldad figured out he hated debt and that it was worth a short-term sacrifice to conquer it.

Maybe today is the day you develop that warrior mentality.

One Measure of Wealth

If I were training for a 5k, I could find lots of people willing to show me their training diary. I could pretty easily find someone at about my level and see their training distances and times. I could use this information to gauge my own performance.

When it comes to finances finding this kind of transparency is tough. Employers don’t want employees comparing pay rates. Most of us have been trained and conditioned to keep our money life secret. This lack of transparency makes it difficult to learn from the few that are doing really well with their money.

If you knew one of your friends had no debt and lots of savings, you might be inclined to find out how they did it – or perhaps even more motivating, if you knew your friend or neighbor with the nice clothes and the new cars was being harassed by bill collectors every night, you might want to learn how to avoid following in their footsteps.

If you don’t have a good measure of where you should be, there’s no way to know how well you are doing. A few years ago I thought I was doing really well. I was paying my bills on time and I certainly had a bunch of stuff. It turns out, how much stuff you have is a pretty poor measurement of your financial health.

In the book, The Millionaire Next Door they used this assessment:

Multiply your age times your realized pretax annual household income from all sources except inheritances. Divide by ten. This, less any inherited wealth, is what your net worth should be. You can use this calculator to find out where you stand.

For example, if Mr. Anthony O. Duncan is forty-one years old, makes $143,000 a year, and has investments that return another $12,000, he would multiply $155,000 by forty-one. That equals $6,355,000. Dividing by ten, his net worth should be $635,500 if he were an Average accumulator of wealth.

If your net worth is twice what is expected for your age and income , yeah you, you are a prodigious accumulator of wealth! If your number is significantly less than predicted by the formula, it may be time to scrutinize your relationship with money.