Some all in all good advice. One of the keys in there was having 6 months worth of expenses in CASH on hand (bank account) and not to count on credit cards for this.

The important thing there is to not get into debt should you have an employment issue, or sudden expenses (medical emergency).

@RBecho: 6 months of expenses in cash is a smart thing, but not always possible for people.

Put as much money away as possible (6 months is a great goal), but having a high-limit, low interest credit card available for emergancies while saving can be smart. If you're worried about using it, one tip I picked up is putting the credit card in a metal tin (Altoids tins work well for this), put the credit card in some water, and then put in the freezer. When you need it, put the tin in boiling water to retrieve the card.

@RBecho: I'm a bit of a contrarian on the "6 months" thing, for those who have good credit and solid work history. I usually stick with 3-4 months and be sure to have a lot of unused credit available. That way, I can use my resources in a two-tiered system depending on how dire the circumstances.

I just don't like tying up lots of cash in very liquid form when it can be used for retirement investments, etc (which could also be liquidated in times of financial hardship). YMMV depending on working spouse, number of kids, etc.

Not all debt is bad, eg. student loans and mortgage debt (if you have a good fixed rate). So I don't agree about the 0% "ideal".

In a perfect world debt payments shouldn't exceed 0% of your monthly income.

i can't agree with that statement. if the cost of an opportunity missed by not going into debt exceeds the cost of the debt itself, then one is doing themselves a great injustice by avoiding debt altogether, no?

education would be the most visible argument in favor of debt in the pursuit of greater wealth in the long-term.

don't mind me...cleaning up a missed tag

Your monthly mortgage payment (including property taxes and insurance) shouldn't exceed 28 percent of your gross monthly income.

This is repeated everywhere (I confess I used it as a rule of thumb when getting my home loan), but the more I think about it the less sense it makes. Why is your gross income the standard? My mortgage payment is well below 28% of my gross income, but just about half of my net monthly take home pay (after taxes, 401k, health insurance, etc). Since net income can vary so much between people, shouldn't it be the yardstick?

Can anyone fill me in on this?

@teapartys_over: How is student loan debt and mortgage debt better than $0.00 debt?

At 0% debt, you don't have to worry about tax deductions cause you didn't have to pay out the interest in the first place.

@linus: I personally believe that it is possible for almost everybody to acquire six months of emergency money. I didn't think I could ever do it, especially after getting married and having a child, but we did it anyway. Exceptions may be the elderly, the disabled, or single unskilled parents of many children. Or students. In their case, other options may be available.

If not, then they are living beyond their means and need to re-assess their spending.

I know the feeling of security that a CC can give. I experienced a moment of butterfly stomach as I cancelled my last credit card (Outlined in a previous post). I considered that to be a psychological attachment to the feeling of security it gave me, and it made me mad that I felt this dependence on a CC. They don't care about you. They care about making a profit.

@teapartys_over: Agreed, in fact I'd take it a step further and say that financially smart people see cheap credit as a boon right now. If you qualify, you can borrow dollars cheap now, and the lender really takes it on the chin because as inflation rises the dollars you repay are worth less than the dollars you borrowed.

In other words, taking credit now, while it's cheap, effectively gives you a "hedge" against inflation.

But of course it's all predicated on the notion that a borrower can responsibly manage their credit.

@teapartys_over: STUDENT LOAN DEBT IS NOT BAD? I must respectfully disagree. Non-Bankruptable; the only type of debt that they can garnish your wages WITHOUT a court order, usually upwards of $20,000 and higher, interest rates higher than my MORTGAGE...

When I kick Sallie Mae out, I will finally be debt free, and I'm going to write a song about it, I'll be so happy.

@humphrmi: Could this cause a "Credit Crunch" in the future, similar to the current "Mortgage Crisis"?

@Fist-o: It may be possible, but is it financially smart?

I put all my spare income into retirement accounts, except a very small (~$200 / Mo) cash savings I allow myself. At that rate, it will take me years to save six months cash.

Sure I could stop making 401(k) or Roth IRA contributions, But what about the lost growth? I would rather take the risk that I need to liquidate part of my 401(k) (after all my other savings is depleted... and I do have a *few* months worth of liquid cash saved...) against missing the growth opportunity that will support me for many years, rather than six months, in my retirement.

@Fist-o: Sure, it could, but again, only if borrowers don't responibly manage their money.

@failurate: If you dont go to college in order to stay at 0% debt. Or if you simply dont buy a house because you don't want to go into debt. Sometime debt is necissary, but only when the gain exceeds the cost.

The $600 I spend monthly on mortgage interest is much cheaper than I would pay to rent my house, and that amount will go down over time as I pay off my mortgage making it an even better deal. Plus I get to write it all off at the end of the year, something you can't do with rent.

@failurate: It can be better to have debt than not to have debt because there is an opportunity cost to not having debt. That is, you are giving up the opportunity to do something else with the money that you are using to pay down debt. For example, look at mortgage debt. You can pay it down early if you have the money available, and this will certainly save you from paying as much interest in the long run. Or, you can take that money and invest it somewhere else. If that investment generates returns at a higher rate than the interest rate on your mortgage, then it's better to invest. In other words, the leverage the mortgage provides you allows you to make MORE money than if you didn't have any debt.

Of course, there are a lot of variables there. For example, must you take a substantial risk with your money to beat the interest rate on your mortgage? Are you taking too much of a risk to keep a mortgage on your house if there is a down market (generally no, in this scenario, since you now also have a pile of cash from the alternative investments that you could use to pay down your mortgage at any time).

@failurate:

@teapartys_over: How is student loan debt and mortgage debt better than $0.00 debt?

@Troy F.: Exactly.

Part of the difference of opinion on this, I think, is risk tolerance. Why do people think that hedge funds and such take on debt? It's simple...it's because it can magnify their gains (just like mortgage debt can magnify people's gains and losses on real estate). It's leverage.

Wait! David Jones LEFT the Monkees to work at Debt Counseling?

Lots of people get in trouble because of simplistic categorization of student and home loans as "good debt". It is good if you use it wisely, but not every student loan and not every home loan is good.

Borrowing as little as you can get by with to go to a state school or a really well respected private school is good.

Borrowing the max possible to go to an obscure private school to major is something very esoteric and hard to market is bad.

Borrowing on a fixed rate loan to purchase a modest house in a reasonable housing market is good.

Borrowing on an interest only ARM to buy an enormous house in an overinflated housing market is bad.

Every situation has to be analyzed separately.

@humphrmi: Interesting. So in your case, you've leveraged risk against your retirement funds. (By that, I mean, you are risking that you won't have an emergency, vs. the hit you'd take on your retirement funds to pay for it). I personally do not wish to take such a risk, so for me, the interest lost by NOT putting that money into retirement, but instead into the ING account, is worth it. I suppose it's a question of risk, and how much one cares to take.

I think it's great you think about retirement; the catch-22 is that the younger you start, the better off you are; yet the young very rarely contribute into a Roth or 401k.

In either case, though, I still disagree with Linus' idea of keeping a credit card in the freezer for emergencies. My freezer is too jam packed with batteries, coffee, and all the other weird crap that you're "Supposed" to store in the freezer! The article in question specifically outlined the guy who did such a thing, and got screwed.

@teapartys_over: Agreed. Debt is what makes the world go 'round actually. Debt is something you should be entering in order to invest in yourself so you can make/produce more in the future than you do now and do it faster. I could save up $$$ to start a business debt free, but that would take years. Or I could go into debt and start a business now and in have a higher profit margin over the years I would have been saving up to start the business. However, the key is not to have TOO much debt or debt that is not appropriate (i.e. credit card debts due to spending a bunch of money on expensive, unnecessary clothes).

As for the 6 months salary thing, I'm getting towards having that saved up, I'm at about 4.5 months. But I think that within the next two years that'll be wiped out so I can buy a house. I hate renting but houses around here are way too expensive.

@TWinter: Yes, obviously a critical part of the analysis should be whether it actually makes sense to spend the money you're spending on something. Is that education or house actually a good investment? Too many people skip that step. Simplistic maxims are always problematic if you don't understand the underlying reasoning behind them.

@Fist-o: Mhmmm. My friends and I seem to be the odd ones out. Most my friends I graduated with took retirement plans into consideration when looking for a job, the others are in grad school. I'm fortunate enough to work for a company that matches up to 10% of annual salary for our 401k, and our 401k plan itself is pretty good with a lot of options (even direct stock market trading if we really want to). So I've been contributing 10% of my salary since I've been able to contribute, which really makes it 20% of my salary. That makes me nice and ahead of the game when compared to many other people my age.

@bonzombiekitty: ten percent?! Damn, you guys hiring?!

@Fist-o: There are a lot of reasons why young people today tend to contribute less to retirement plans than older people.

* They make less money.
* They have more student loan debt, since college is far more expensive now than it was when Boomers were young.
* Fewer of them are even in jobs where they can get a 401(k), much less a matched one.
* They have other financial needs that older people don't, like saving for their first house.

That being said, I do think that some of it is simple ignorance and lack of long-term planning. But some of it is also that younger people have been given a raw deal compared to previous generations in that wages aren't increasing, education is so expensive, pension plans rarely exist anymore outside of a few large companies or government jobs, etc. Personally, that motivates me MORE to save more, since I know that no one else is going to be looking out for me. But I also think that the end result of this is going to be a lot of people with no retirement plan. This will probably result in political pressure and eventual government intervention.

I definitely agree that prudent use of debt is a good thing.

If businesses relied solely on organic growth, they'd be in constant cash crunches and capital expenditures would almost never occur. It typically takes companies many decades of success before they can self-finance, self-insure, etc.

If you treat people the same way, then the comparison holds...but since consumers typically use debt to buy depreciating assets (toys), it's more like a poorly-run company.

@Fist-o: I have to agree. Student loan debt has to be the worst debt to have for exactly the reasons Fist-o stated. Even a crappy predatory credit card has some potential for some redress or relief if you get in a bad situation.

@Fist-o: STUDENT LOAN DEBT IS NOT BAD? I must respectfully disagree.

i must respectfully disagree with your disagreement. my student loan debt costs me $80/mo ($960/year) at 2.75%APR. over 10 years, that money costs me ~$1200 to borrow. i also contribute $320/mo into my 401(k) which is currently performing at ~8%.

now, if i forgo the 401(k) contributions & accelerate my student loan payments, i could pay them off in 2 years & then contribute the full $400/mo into my 401(k) & save ~$1000 in interest payments.

HOWEVER, i will have lost approximately $5000 in interest (assuming a constant 8% return on investment). even though the contributions are the same ($320*120mo = $400*96mo = $38400), the amount at the end of that 10 years is very different ($58,542.00 vs. $53,547.00).

so there you go...there's my personal example of why debt is GOOD (sometimes).

@teapartys_over:

Not all debt is bad, eg. student loans and mortgage debt (if you have a good fixed rate). So I don't agree about the 0% "ideal".

Student Loan debt is at a low rate, but you're paying interest - that's not "good".

A house is an asset that typically appreciates, but you're paying radical amounts of interest over the history of the loan - that's not "good".

@bohemian: Yes, student loan lenders have gotten rather predatory and their lobbyists have rewritten the laws in their favor with the compliance of a Republican Congress and president. I do think that some of those things should be reformed to restore some basic consumer protections to student loans, especially private ones. But the solution is not to just not go to college if you can't afford it outright. The solution is to elect people that will not write horrible anti-consumer lending laws.

@johnva: Any reasonable savings plan should factor in the massive tax increases that we'll see when the government finally realizes that they can't fund social security anymore. Smart people invest in both their 401ks AND their IRAs.

For all the people saying there's no relief from student loan debt: try joining the Army. When I joined, back in 2001, they would pay them off up to $60,000; that number has most likely increased. Also, enlisting in the military doesn't ruin your credit rating.

@InfiniTrent: Wrong. Some debt allows you to make more money than if you didn't have debt at all. That's the whole idea behind business loans. Read and understand this article: Leverage

@Erwos: Oh, I agree. You should do whatever you can to save as much as possible for retirement in tax-advantaged accounts. I think the most likely outcome on Social Security is going to be a combination of tax increases and benefit cuts, BTW. The benefit cuts will be camouflaged so that they aren't so obvious to people.

@johnva: really? i'm under the impression that one day they'll just stop the printing presses, shutter the office doors, dead circuit the phone lines, 404 the website & pretend like it never existed.

"what is this social security you speak of?"

@johnva: I guess it's wishful thinking that when the well runs dry that clusterf*** would just be abandoned :-(

@bohemian: Are you kidding?

Well, I guess it depends on who you borrow from, but all my student loan debt is federal, and the interest is low, and I can get deferral for any reason. Have you ever tried telling a bank that you won't be making your payments on a loan or credit card balance for the next six months?

It's an investment, and sure, there are always bad investments. But is the loan likely to pay for itself through higher paying jobs? What is the opportunity cost of waiting to go to school until you have saved enough? Would your course work be affected if you try to balance it with a full-time job? More likely than not, I say it's an investment worth making.

@humphrmi: "I put all my spare income into retirement accounts, except a very small (~$200 / Mo) cash savings I allow myself. At that rate, it will take me years to save six months cash."

Yes, this is also my concern. I *could* get to six months, but I can also be using that to fund my retirement account, pay down my mortgage to get the PMI taken off, pay down student loans (got rid of the variable rate ones, yay!), etc. Right now I'm at about 3 months in dedicated emergency savings (plus some other cash in "saving for car for when car breaks down" and "general savings" and "house needs fixin'" kinds of savings, which maybe adds up to six months sometimes, but not other times), and I'm not sure how hard I want to work to increase that.

I also come from a large, close-knit extended family, and the assumption is that in money crises, the extended family is a unit. I would expect in a catastrophe that relatives would make zero-interest loans available or other help as we needed it and they could afford it. Similarly, I'd make that help available to them. With that "private" safety net available, I'm not sure six months is an advisable goal when I also need to save for retirement.

OTOH, the psychological freedom that'll come from knowing I have six months in reserve is probably worth it to me; I'll probably get there eventually!

@mac-phisto: That goes to show that every situation is different.

My student loans are at 7.625%. AFTER Consolidation.

@Erwos: All things considered, social security isn't in that bad a shape, at least compared to other federal programs (we should be more afraid of what baby boomer retirees will do to Medicare).

I do agree with your overall point - tax increases are inevitable (plus, social security was always meant to be a safety net, not a nest egg - though I do like to see the Feds set up some sort of sovereign wealth fund type thing and reinvest the SS funds).

And just to make you all jealous... I've worked for a state institution, who, for the past 5 years, has contributed 12% of my income without me having to match it, into a 403b.

Of course, state institutions typically pay less than industry, so... I guess really they're just forcing me to invest 12% of my income into retirement. But I would do at least that anyway, so, I have no problem with it.

@mac-phisto: @Troy F.:

Well, Social Security can't go totally bankrupt as long as the SS payroll tax exists. They will always be able to pay out what they're currently taking in, which is something like 78% of projected benefits they will owe or something like that if I recall correctly. The problem comes in when the tax revenue is no longer sufficient to pay for all the people who are retired. The solution is that they can raise taxes or cut the benefits, or both. But I think without a change in the law, the "default" will be that they simply won't pay out all the benefits promised if there is a shortfall. This demographic shortfall was supposed to be covered by the "trust fund", which is money the general treasury owes to Social Security. That money also legally has to be paid back, but the only way that can happen is if either income taxes are raised or spending is cut somewhere. In other words, the SS Trust Fund was spent on stuff like the wars in Iraq and defense spending.

Remember, SS exists for a good reason. The reason was that in a time of economic collapse (the Great Depression), too many retirees were totally screwed and couldn't even feed themselves. I think a social safety net is a good thing for this reason. Whether the current form of SS is the best way we could that is debatable. It would certainly be cheaper to (for example) make SS more like welfare and pay it only when people are truly in poverty. The problem with that is that the program's longterm political support rests partly on the fact that it benefits everyone directly. And that might also discourage people from saving on their own.

I don't understand how I'm supposed to stay below 48% when my student loan payment alone is 40%.

@mac-phisto:

Can you please enlighten me on how to get a 2.75% student loan... mine are all upwards of 6% with one of them around 7.75%

those percentages are completely out of reach for a household not making a 6 figure income. maybe with 2 incomes, but even that is skewed, since you would need two reliable vehicles.

First off - car loan:

so your non-mortgage monthly debts should be 20%, or less, of your income, but you shouldn't ever take out more than a 3 year loan on a car.

so for a person making $50,000 a year, they would probably net around 2900 a month, and 20% of that is $583.

but if you finance $20,000 on a car loan, which is about as cheap as cars get, if you get a 36 month loan at a respectable 6% interest, you're looking at $608 a month right there.

$50,000 a year isn't peanuts, and to maintain what is most likely a professional job, a reliable car is part of the deal. There is no way you can keep that payment anywhere close to reasonable based on the 20% rule on a 36 month loan.

And then mortage debts - you shouldn't spend more than 28% of your income on your mortgage. for that $50,000 a year person, that would leave a hair over $800 a month for mortgage - counting insurance and taxes. That might get you a $90,000 house. And what does $90,000 buy in a house?

@xthexlanternx: Mine is at about 7%, all with AES. The only way consolidating lowers my monthly payments is if I extend the term of the loan to 20 years.

*looks at loan balance*

ughhhh. I feel like I'm not making any progress on that thing. I can't wait until 2016 and I can pay the darn thing off. That's a big chunk of my expense.

@TheWraithL98: I totally disagree.

You can get a car for well under $20k. Just buy a used car. Our monthly car payments were only $350-$375, and that was only over 36 months.

And the answer is, no, you can't afford a house. Save up a bigger down payment, and rent in the meantime.

Here's my problem with people investing in retirement accounts heavily BEFORE paying off consumer debt like Credit Cards, and other debt like Student Loans:

Even if you make reasonable returns in your IRA or 401(k), say 10%, what good is that if your debt is accruing interest at 6-10% also? You're offsetting your gains through the interest you're paying.

I'm contributing to my 401(k) only enough to maximize my company's match, then throwing virtually all of my spare money at getting out of debt - once I'm out of debt, I can invest the interest I would have paid into my retirement or other investments.

People, kill all your debt (maybe not the mortgage, since it has an asset offsetting the debt) THEN invest and save - you'll have more money than you imagined.