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| The Basics | Budget busters happen, so plan for them
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They're the expenses you face only on occasion, but they can be a pain: a new car, new roof, legal bills, and so on. Here are some ways to confront them.
By Mary Rowland
Most of us strive to stay out of debt, work from a budget, and squirrel away money for major purchases. But we all face budget busters: putting a new roof on the house, repairing the car, replacing the hot water heater, paying legal bills for a divorce.
It's for this reason that planners tell us to set up an emergency fund. Yet that doesnt always cover the unexpected or the uneven expenditures.
However, a properly planned budget can cover these irregular expenses. Your savings plan can include regular payments into a money market account or certificate of deposit account thats specifically earmarked for these expenditures. For longer-term expenditures like a roof, you probably should look at keeping those funds in something that pays a higher return, like a mutual fund, until a couple of years before youre going to need the money. Then park the money in a money market account.
You know youre going to buy a new roof in 20 years and a new car in three years. Determine how much youll have to save to reach those goals in specifically designated accounts. Its a discipline that pays off financially as it avoids putting yourself in debt -- and in situations where youre trying to pay off credit cards with interest rates of 18% or higher.
Still, even planners face financial emergencies and find that the money isnt always available. Consider Bob Winfield, a financial planner in Memphis. He and his wife, Carol, too, decided to adopt a baby.
One Wednesday afternoon, Winfield got a call at work. It was a young woman they had talked with about adopting her unborn baby. She had been unable to decide. Now she was at the hospital and she wanted to go ahead with the adoption. Winfield had only a couple of days to come up with the money for medical and legal bills, which he borrowed from a bank.
List good reasons for going into debt
Like the Hensons and Winfields, most of us are occasionally forced to dabble in debt. We should all have a plan in place so that we know what to do when that happens. The first step is to think about what you consider legitimate reasons to go into debt. Make a list. Most likely they fall into two categories: emergencies and opportunities.
Add to your list unexpected opportunities. That would not include the opportunity to enjoy a good bottle of wine. But it would certainly include adoption. Certain business opportunities might go on the list, too. Most people need to borrow if they start their own business, for instance. That would still qualify under admonition of many financial planners that you should borrow only to create something of lasting value.
For emergencies: a home equity line
Where to go? Most planners say the best place for emergency money is a home equity credit line. Interest rates are low -- perhaps one point above the prime rate -- and the interest is tax deductible. Jane King, a financial planner in Boston, likes home equity lines so much that she urges clients to set them up instead of an emergency fund.
With interest rates so low, King prefers to keep assets working in the stock market rather than earning 5% or so in an emergency fund. "A home equity line gives you an anchor to windward so you always have that money waiting for you at single-digit interest rates," she says. "And you don't have to keep money in the bank at these insulting interest rates."
When you set up a home equity line, be certain to get a credit line and not a loan. A credit line is available credit waiting for you to tap into. But there is no cost unless you actually write a check on it and make the loan, King says. The time to set it up is when you don't need it. If you should lose your job, it would be much more difficult to obtain the credit line.
Strategies to discipline yourself
Of course, you should tap into it only when you need it. And you should have a plan to pay it off as quickly as possible. If you lack discipline, play a game with yourself to get the loan paid off. For example, if you decide to pay it off in a year, make a little coupon book for yourself like you might get with a car loan -- with 1/12th of the balance on each coupon -- and put it with your bills.
Remember the rule that you should pay yourself first. Getting out of debt is part of paying yourself first, so that you can get out from under the debt and save the money youre paying in interest.
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MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.
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