Financial Makeover: Advice for New Parents
— -- Q U E S T I O N: My husband and I have a 3-month-old daughter and her childcare expenses; plus mortgage, car, appliance, school loan and utility payments. We don't have credit card payments because we consolidated our debts and paid them off in full a year ago. The car and appliance purchases were necessities, as we had to replace nonfunctional items with working ones. What should we be doing to prepare for the future?
A N S W E R:Angie and Terry are in their early 30s with a newborn child and are facing a wide array of financial planning issues. They want to establish a college fund, begin building a retirement nest egg, and possibly repay some of their student, auto and consumer debt … all without having to take on a second (or third!) job.
They suspect that they need to do some tax planning to make sure that they're taking advantage of tax-saving opportunities. Moreover, since they are new parents, it's important that they think about purchasing sufficient life insurance and preparing a basic estate plan.
Angie's and Terry's situation is not uncommon, and with a little planning they can be on their way to securing their financial future.
Expect the Unexpected
Unexpected expenses and events can wreck even the best financial plan, so before thinking about long-term goals such as retirement or college education for their daughter, Angie and Terry need to ensure that they're prepared for the unexpected. Angie notes that they recently had to replace several appliances, and they financed the purchases with credit. Unfortunately, consumer credit often carries a very high interest rate and should generally be avoided. Accumulating a cash reserve equal to three months of take-home income would cover most of life's unexpected expenses (such as new appliances or car repairs), without having to resort to expensive consumer credit. They should set aside this reserve in a bank savings account or money market account, where they can easily access the money in a pinch.
Angie and Terry own their home, which may be an additional source of liquidity if they've owned it awhile and have some equity. They should consult with their bank or mortgage lender about establishing a home equity line of credit, a relatively low-cost credit line that they can draw up to pay for large unexpected expenses and then pay down over time. (Think of a home equity line as a credit card that's tied to your house.) At current rates of as low as 4 percent to 6 percent, home equity lines can cost much less than most consumer debt, which often carries interest rates of 18 percent or more. Moreover, home equity interest (on credit up to $100,000) is tax-deductible, unlike interest paid on credit cards and automobile loans; consequently, if they have sufficient equity to qualify for a low cost credit line, Angie and Terry should consider paying off higher-cost automobile and appliance loans with a home equity loan.
One word of caution: Home equity lines, like credit cards, can make it very easy to spend on frivolous or unnecessary expenses. Because a home equity line is secured by your home, missing payments can lead to your home being repossessed; consequently, the credit line should generally be used only to bridge temporary cash flow shortfalls caused by large, necessary expenses. Fortunately, Angie and Terry appear to use credit very responsibly, so they're not likely to have a problem.
Thinking About the Unthinkable
No one likes thinking about their own mortality, but now that Angie and Terry have a child it is very important for them to address the question of what would happen to their surviving family members if one or both of them died prematurely. They'll want to make sure that any surviving spouse and young children have adequate resources to maintain their current standard of living should one spouse die. For many families, this means purchasing life insurance to supplement the savings and investments that they have already accumulated.
Related Stories
ABC News Live