Debt Management

Step 1: Identifying Your Financial Goals

Most of us have one or two specific financial dreams that we would love to obtain within the next few years. You may long to own your own home by 30. You may want to open a practice by the time you are 35.

The first step toward turning your financial fantasy into an achievable goal is calculating the dollar value of your dream. Take for instance: A home. In December 2002, the minimum household income needed to purchase a California, median-priced home at $338,110 was $81,120. This is based on a typical 30-year, fixed-rate mortgage at 6.10 percent and assuming a 20 percent downpayment. (Source: California Association of Realtors)

A New Car. Expect to make a down payment of 10-20 percent on a new automobile. To buy a $20,000 car, you will need to have from $2,000 to $4,000 in cash.

An Emergency Saving Fund. Generally, an emergency fund is equal to at least three months' worth of living expenses. The amount will probably guard against a total or immediate disruption of your life, for example you are laid off from your job. Accumulating enough savings for a financial emergency is something you should consider a necessity.

To Do: Make a list of your personal financial goals.

Step 2: Learning How to Reach Your Financial Goals

Once you have determined what your goals are, you are ready to work toward achieving them.

Refer to the Savings Plan to determine how much you need to save each month to meet your goals. The table gives you a rough idea of how much you need to put aside each month to end up with a specific dollar amount, in the set number of years. The table assumes that inflation will be 4 percent and the money you put away will earn a rate of return of 8 percent before taxes. It also assumes that your combined federal, state and local tax rate is 33 percent for the next 10 years. If you tend to be a good saver, you may not be deterred by the amount you need to save each month. If you are like most people, you will probably have to save more than you think you can spare. Don't get discouraged. Step 3, will offer advice on how to get this money from your current income. Even though you may decide you have to adjust your financial goals, or the amount of time it will take for you to reach it, at least you will be on your way toward making it happen.

Step 3: Figuring Out Where Your Money Goes

Saving isn't easy for most people and putting aside a fixed amount each month seems like an impossible task. But the fact is, you probably can save, even if you feel like you are barely making ends meet. The key is gaining control of your current spending habits and then reevaluating your priorities. This section will help you do the necessary financial soul searching it often takes to achieve specific goals.

The first step is to keep a detailed spending diary for two weeks so that you can get a better sense of your regular cash expenditures. If you use a personal finance program (i.e., Quicken, Microsoft Money, etc.) the software will itemize each expenditure. If you do not use a software program, use a PDA or a notebook and write down everything you purchase. This sounds like a tedious exercise, but your will find it is a very useful way to track your cash flow.

• Tip: If you withdraw money from an automatic teller machine (ATM), use the back of the withdrawal slip to record how you spend the money.

Expenses should include everything: magazines, snacks from a vending machine, lottery tickets, lunches, parking, donations for gifts, etc. When you put your hand into your pocket or purse to get money out, write it down.

At the end of the month, review the list and the total for each expense category. Once you have done that you are ready to complete the Out-of School Financial Budget.

Tips for completing the Out of School Financial Budget:

• It is not necessary to be exact.
• Household Income: Use your pay stubs and your bank statements to come up with reasonable estimates.
• Fixed Expenses (per month): A quick and easy way to estimate your Federal and State taxes is found at FinAid.org.
• Complete the Student Status and Family Information sections
• Skip down to Students Information and enter
• State of Legal Residence
• Student Age
• Adjusted Gross Income
• (skip Federal Tax Paid)
• Earned income (student)
• Earned Income (spouse) if applicable
• Then scroll to bottom and calculate. The Allowances of Federal, State and FICA tax estimates will be quoted.

Living Expenses: use your spending diary, check book register, ATM and credit card receipts.

• For large expenses (such as furniture, travel, etc.) come up with a monthly estimate.
• For expenses that vary from month to month (i.e. car repairs or clothing) take an average from four to five months worth of expenditures.

Once you have completed the budget calculator, review the budget summary. If you come up with a negative balance, you will need to consider your priorities and make some difficult financial decisions. For instance, would you be able to save $150 a month by cooking at home rather than eating out every other night? Do you spend as much on clothes as you do on rent? Are you frequently experiencing San Francisco fine dining and nightlife? Is your car costing more than it is worth? Am I spending money the way I want to? Can I make any changes?

With these questions in mind, go back over the entire living expense section. Consider where you can cut back, and by how much. Once you have done that, check the items that you feel are absolute necessities. For most, that includes the fixed expenses of taxes and student loans and the living expenses of housing, utilities and food. Subtract your necessities from your total income. The answer (which is positive, hopefully) is the amount of discretionary income you have left for living expenses. A portion of that money should be reserved to meet your savings goals, and the rest is for items that are not necessities. At this point it should be clear whether or not you need to adjust the size of your financial goal, or the number of years in which you can realistically hope to attain it. Try out your new budget goals for a week. You may find that you will need to fine tune some expensed areas. (But not your saving!)

Step 4: Financial Rule of Thumb

To assist you in evaluating whether your current spending and saving habits are right on track or wildly off base, listed a few financial rules and tips. The following will give you financial philosophies to strive for. Realistically, the rules are not always possible to attain, but it is good to set high goals. Use the results of the Out-of School Financial Budget to help with your calculations.

• The Debt Rule: Your total debt (excluding student loans and mortgage payments) should be less than 20 percent of your annual take-home pay. To see if you meet this standard, list all the money you owe, including unpaid balances on your credit cards, your car loan, and any other lines of credit, and add these amounts together. (When student loans are calculated into the total debt most residents fail the debt-rule test. Fortunately, mortgage lenders tend to be more forgiving of borrowers with student loans than of those with lots of credit card debt. For this reason we asked you to exclude your student loans from this calculation. Just make sure the total of all your other loans, especially credit card balances, fall well below this 20 percent mark.)
• The Housing Rule: Spend no more than 30 percent of your monthly take-home pay on rent or mortgage payments. Living in San Francisco, you probably won't meet this guideline unless you share a place with roommates or you don't mind living in a small studio.
• The Savings Rule: Save at least 10 percent of your take-home pay each month. It is critical to think of your savings as a fixed monthly expense that is part of your budget, just like your car payment and your rent. Sound impossible? Consider this, your employer just gave you the choice to either receive a 10 percent cut of your take home pay or you would lose your job. Most would select the 10 percent pay reduction and adjust their monthly spending. The point is, saving 10 percent of your earnings a month can realistically be done.

Step 5: Tips on Reducing Monthly Expenditures

The following are tips that may assist you on reducing your living expenses:

• Access Group "Be Thrifty..."
• Drowning in Debt! Credit Counseling May Help

Step 6: Creating a Financial Filing System

As you begin to establish your budget goals, it is recommended that you set up a financial filing system. The easiest way to do this is with file folders and an inexpensive cardboard filing cabinet. Set up an "in box" to store monthly bills, statements and receipts. The best time to file is when you pay your monthly bills. The following is a list of folders you may need.

• Auto Loans
• Auto Other (repair, warrantees, etc.)
• Bank Statements
• Brokerage Accounts
• Credits Cards
• Home Improvements
• Home (Purchase) or Rental/Lease Agreement
• Insurance
• Individual Retirement Accounts
• Medical Records
• Mortgage Interest Payments
• Mutual Funds
• Pension Plan/Retirement Plan Statements
• Personal Documents (passport, social security card, marriage certificate)
• Property Tax/Real Estate Tax
• Salary
• Student Loans
• Tax-Deductible Items
• Tax Returns
• Warranties, Rebates, Receipts (for all major purchases)