Recession and Revised Plans

Last year I posted about an extremely ambitious personal finance plan that my husband and I took on in July. We wanted to pay down the principle on our mortgage by an additional $50,000 - above and beyond the paydown we'd see with just our normal monthly payments - over the following 12 months.

Well, that was before it was generally known that the US had entered a recession in December of 2007. Despite the downturn in the economy, we did very well with our goal up until the beginning of 2009. We have not reached it, and as of January, we decided to change tactics and put that goal on hold. You see, right now it looks as though my husband will be out of a job at the end of June.

By any middle-class measure, he's very well compensated for what he does. But he works on a contract basis, and right now it looks somewhat unlikely that his contract will be renewed after June 30th. He had a job offer late last year that appealed to him, and which he intended to accept after June. But that offer evaporated along with the rest of the economy several weeks ago.

Having no debt other than our mortgage, and having built a cash emergency savings to cover six months of expenses, we're situated as well as can be expected to weather a period of unemployment for the main breadwinner in our household. I've been more diligent about doing the various things I do to earn money. And we can be fairly sure we won't go hungry any time soon, given the garden I have all planned out for this year. Still, it's a scary thing to contemplate: losing our income.

Right now we still have almost four months of continued income to count on, and that much time for him to look for other job opportunities, hustle for an extension of his contract, and hope that the economy recovers somewhat. In February I canceled the additional principle payments that we were making automatically each month along with our normal monthly payment. That money will buffer our cash savings for the next four months. If my husband finds another job by June, we'll be able to take that money and apply it to our mortgage as a lump sum payment. If not, well, we'll be using it for necessities.

My plan right now is to either refinance or recast our mortgage in early May if my husband has not secured another job. That will lower our required mortgage payment and let us live longer on our emergency fund. If our finances pick up again, nothing would prevent us from resuming automatic additional principle payments each month, though less of our required monthly payment would be applied to the principle. Still, if we lose our main income, that's a price worth paying.

On the other hand, we are also considering a major expenditure that's not, strictly speaking, a requirement. We've asked for estimates for a solar PV and solar thermal installation that would cut our heating bills down to almost nothing. I have no idea what those estimates are going to look like. Before we would pay out money for that, we'd also have our home evaluated for additional insulation needs.

This may sound paradoxical: that we're contemplating a significant discretionary expense when we anticipate the need to live on our savings. We see it this way though; if the economy remains so weak that my husband cannot find a decent job, we want to be able to heat our house next winter without spending much money. Heating is a major expense in our annual budget, and since we heat with oil, that expense is perilously tied to shrinking supplies of fossil fuel. I'm also concerned about the possibility of hyper-inflation. If that occurred, not only would the value of our cash savings be less, but the cost of oil and electricity might easily become prohibitively expensive. Finally, we reckon that a home with solar electricity generation and low heating costs will hold its value better than many other homes. In other words, it looks like a smart investment to us right now.

We've yet to see the estimates for such an installation, so we don't know whether we'll take that plunge. But it's on the table. And if the price is right we may be able to pay for it with a bonus we're expecting based on last year's performance by the company my husband works for. (For the record, that company is not in the financial/banking sector, nor anywhere near it.)

The smaller amounts of money from my earnings that were occasionally applied to our principle are also accumulating rather than being paid out. But part of these funds are being set aside in my mind for spending as well. Mind you, I'm not planning on any frivolous purchases, but I would like to invest in some items that will be of long-term value to us, no matter what happens with the economy. I figure some responsible spending won't be amiss in these tough times either. On my list of things to buy are some extra sets of long underwear for both of us during the coming spring sales, a solar oven, some solar lanterns, and some materials to build housing for some meat rabbits, and to modify our mobile chicken coop this spring. If there's money left after that, I'll buy another 50-pound bag of bread flour, though I'm almost afraid to know what the price has risen to. Basically, I'm looking to put about $500 into things that will hold their value and pay dividends for our budget year after year.

If we are somehow able to squeak through this year without a loss of income - and that's a big if - I would like to start another savings fund for an electric assist bicycle. I understand that these are quite expensive. But I know that sooner or later we are going to have to confront the end of affordable gasoline. A bicycle was my transportation for many years out of necessity, and therefore I've never regarded cycling as recreation, as my husband does. We live in a quite hilly area, and it's more than three miles to reach the nearest spot where we could grocery shop or fill a prescription. The bulk food store is 17 miles away along the flattest route. There is very, very little public transportation in our area, and none right now that would get us to the places we shop. It would be faster for me to walk to the nearest grocery store than to take a bus, and I'd still have to walk most of the route anyway. So far, an electric assist bike is the best transportation solution I've been able to think of to the end of cheap petroleum, and it wouldn't be much fun, or even manageable, on many winter days.

Well, that's where we're at in this recession. I'm not feeling sorry for us; I know we're better situated than many. Still, like everyone else, we are feeling the anxiety. My heart really goes out to those who are already dealing with job losses and financial disaster. If you're not yet in crisis, please think about spending wisely where you are able to do so. Remember that food banks and other charities are stretched incredibly thin right now. If you can afford it, check that box to add a few dollars to your utility bill payment to keep someone else's electricity from being shut off. Plant your garden this year, and share what you can. We're in for more tough times ahead.

We Love Our Credit Card

This month our USAA credit card distributed our annual cash back rebate. It came to $478.40. That's a very nice chunk of change that falls like a gift out of the sky. We charge most of our expenses on our credit card, and pay it off in full every month. Additionally, my husband charged tens of thousands of dollars of business travel expenses on the card last year, all of which he was reimbursed for. We get a tiny portion of those charges kicked back to us in by way of this rebate. The card has no annual fee, and right now the APR is only 4%. I had to look this up because I never pay any attention to the APR. Not having to think about the APR is a nice perk of paying off our balance each month.

January is a nice time to get a little extra cash. Some might use it to pay off holiday gift purchases. Others (*cough*) might stuff it into their heating oil tanks. It's less than a 1% rebate for all the charges we made with the card, but given that the card doesn't cost us a penny to carry and use, I don't see any downside. We likely won't get anywhere near this much back next year since my husband will be traveling much less for business.

Now USAA offers credit cards and other financial services only to its membership. You become eligible for membership through military service in the US, or by being the child or spouse of a member. Obviously, this is means a lot of people are not eligible. But if you are eligible, you'd be crazy not to avail yourself of this fantastic resource. USAA offers the best customer service I've experienced from any business, ever. But there are other cash back credit cards out there.

Credit cards, like any other tool, can be used or abused. When your financial house is in order, it's possible to make this tool truly work for you. Even if we had missed paying our bill on time once or twice during the year, and incurred some interest, plus late fees, we still would still have come out ahead with this cash back card. On the other hand, if we were carrying a large balance month after month, the $478 rebate would quickly get eaten up in fees, even at the very low APR of just 4%.

If your finances are in good shape and you trust yourself not to rack up a balance you can't pay off, I recommend looking for a good cash back card with no annual fee. So long as you pay your bill on time and in full each month, you'll see a nice rebate once a year. It's sort of like getting a tiny discount on everything you pay for by using your card. And if you're doing a lot of reimbursed business travel you should definitely get a little something back, besides useless frequent flyer miles, for all those nights away from home.

What Would You Do If You Lost Your Job Today?

The economy is a scary thing right now. Many people are losing their jobs. Most of the rest of us are nervous about job security. I've been giving some thought to what would happen if my husband lost his job, which is the largest and most stable income stream we have right now. There are a number of things we could do, if we had to, that we're not doing right now. I've run through them a number of times in my mind, just to make sure I'm considering all possibilities.

What would you do if you, or the breadwinner of your family, lost their job? What immediate steps could you take to cut your costs or replace some of that income in other ways? Here's a list of actions I consider to be "emergency response."

1. Recast our mortgage. We've been paying ahead on our mortgage, which means we've built in the possibility of reducing the amount we're obligated to pay each month. Recasting costs much less than a refinancing, and leaves both the original term of your loan and the interest rate unchanged. This is something I would do immediately upon learning our financial situation had changed. Better to do this as early as possible, rather than wait until a few months' worth of savings has been eaten up. As of right now, our early repayment would let us reduce our monthly mortgage payment by a little over $250.

2. Sell a car. Right now we own two cars we paid cash for, and we don't really need both of them. Selling one car would give us cash in hand, and also reduce our auto insurance rates. I actually wouldn't mind doing it now, but my husband has half convinced me it's the worst time to sell.

3. Get a roommate. We love our privacy, but if our main income stream were cut off, we'd find a way to live with someone else in our own home. We've got a nice place to live and we've got the room. An extra $400+ per month would mean our savings would stretch considerably farther.

4. Look for a straight job. If my husband lost his job, I would look for steady work. It would likely be for low pay, and given the economy, any job at all would likely be hard to come by. So I would make sure I'd settled the first three items on this list first, since those would be fairly easy to accomplish. He would make his own job search a 9-5 chore every day.

5. Increase the hustle. There are a number of things that I do that bring in a small income, such as some paid writing, and teaching cooking classes. I'd do a lot more of them, and also work on bartering even more than I already planned to this year.

6. Expand the garden and work it more intensively. Last year was the first year I gardened seriously enough to supply a lot of our own food. If things got bad for us this year, I would ratchet it up even more by clearing as much new ground as I could find, though there really isn't a whole lot left to clear that would produce a good crop. But spending more time out there tending it would give us better yields. Building cold frames to extend our growing season would become a bigger priority.

Surprisingly, when I considered what small economies I could make in our day-to-day routine, there really wasn't all that much we would change. We already live very frugally in terms of how we spend and conserve money. I suppose we'd not buy any more alcohol when we ran through the beer and cheap wine we have in the basement, and we might eat a little less meat. Other than that, there aren't many places to trim our monthly budget.

It's also a little surprising to me that bartering and cold frames showed up on my list of goals for 2009, as well as on this emergency list. So it looks like I'll be slightly better prepared for any financial emergency by the end of this year if I achieve my goals.

If you assemble your own list of crisis management steps you'd take in a financial pinch, it's worth asking yourself why you haven't taken those steps already. I admit that all of the things on my list (other than recasting the mortgage) are things that I "should" be doing already, if I were really serious about frugality. Mostly it boils down to issues of our quality of life. We could and would do things differently if we had to, but not without sacrificing something significant. The truth is, none of the hundreds of little things we currently do to save money feel like real sacrifices. That's the real beauty of a frugal and self-sufficient mindset.

When I run through a what-if scenario such as this one, I can't begin to express how much difference it makes to know that we carry no debt other than our mortgage, and that we have cash saved for a full six months of expenses. Of course the prospect of our main income stream being cut off makes me nervous. But it doesn't make me panic; it's not unthinkable. Living the frugal life affords me the confidence to say we'd get through it, and know that we really would. I feel there are plenty of rewards for living the way we do, but peace of mind ranks really, really high on that list of rewards.

So what steps would you take if you lost your job? Any reason you haven't taken those steps already?

Refinancing vs. Recasting Your Mortgage

I've tried a few times over the last year to refinance our mortgage at a better interest rate than the one we've got. A few times it seemed like it was going to happen, but for a variety of reasons it hasn't, even though our credit rating is excellent and we've proved ourselves good risks on this mortgage.

My most recent conversation was with our wonderful bank, USAA. (If you're eligible for their services but not using them, you really need to look into doing so. You'd be nuts to pass up this much value and genuine customer service.) During the course of the conversation I had with the loan officer, he mentioned recasting a mortgage, which was something I'd never even heard of. It turns out that recasting a mortgage is a pretty standard practice, if not so well known or widely available as refinancing.

Disclaimer: I am not a financial advisor or professional in any way. Speak to a qualified expert for more infomation rather than relying on what I'm about to say here.

Recasting can mean a few different things, but here's how it would most commonly work. Say you've had a mortgage for a few years, and during that time you've been a good little frugalite and have made extra principle payments each month. Or, you've taken a sizeable windfall in the form of a bonus, inheritance, or whatever, and applied it to your principle. In other words, you're ahead of schedule in repaying your loan. At some later point, either because of unemployment or some other financial difficulty, your budget changes and you want to reduce your required monthly mortgage payments. By recasting your mortgage with your current lender, the term of your mortgage and your interest rate will stay the same, but the loan is re-amortized to give you smaller monthly payments so that you will pay off the loan exactly according to the original term of the loan.

Got that? Let's say it again so that we're clear on the concept. You're five years into a 30-year mortgage, but you've been paying ahead. If you keep up the extra payments, you'll retire the mortgage 12 years ahead of schedule. But suddenly you can't make the regular payments very easily anymore, let alone pay extra. If you are able to recast your mortgage, your monthly payments go down. If you stick to that lower monthly payment, you'll pay off the mortgage exactly on the original 30-year schedule.

Why do lenders sometimes offer this? Because it works for both the lender and the borrower. Because you've paid off part of the mortgage ahead of schedule, either with those extra monthly principle payments or with one lump-sum paydown, you've shown yourself to be a pretty good risk, but a low return. Look at it a little more deeply from the lender's perspective. By lowering the monthly payment and keeping the original term of the loan, the lender stands to gain more over time, as opposed to having the borrower pay off the loan quickly and paying less interest in the bargain. More concerning to the lender is the issue that if you, as a borrower, are asking for a recast of the mortgage, you may now be in the market for a refinance from another lender. Worse yet, if the borrower's financial circumstances have changed, he or she may now be at risk of defaulting. Financial institutions don't like defaults on loans. As a lender, it makes sense to work something out that keeps the borrower paying, accepting smaller monthly payments, but making more money over the long run. It's a win-win situation if the borrower is in dire straits.

This is interesting to me as a mortgage holder who has been making substantial extra principle payments. The traditional argument against early repayment of a mortgage is that it's better to invest the money and earn a higher rate of return. (Well, I think we all know just how far out the window that idea has been tossed lately.) But the recasting of a mortgage looks to me like a sort of unofficial safety net for people who have their financial house in order and want to aggressively attack their debt. If you throw every extra dollar at your mortgage and make a significant dent in it, you're essentially putting yourself on a good footing to ask for a recast if your finances take a turn for the worse.

My understanding is that not all lenders offer recasting of mortgages. From what I've heard, if it is available to you, it should cost significantly less in fees than a refinance. Something in the hundreds of dollars range, rather than the thousands of dollars range.

I wouldn't recommend paying down mortgage principle instead of building up a cash savings emergency fund. But it's nice to know that our early repayment efforts give us a good chance at that latitude if need be. I'm not sure why I never heard of this before, but I'm glad I know about it now.

Using the Numbers for Motivation

Sticking with frugality sometimes gets a little wearisome. Whether it's trying to live or eat on a small budget, or trying to come up with money to pay down debts, living frugally is a long term game for most of us. I think I have it easier than most people who are drawn to read or write about frugality, but I still look for ways to keep myself motivated. I'm really not a math buff at all, but I have found ways of using numbers to motivate myself.

Recently I've seen several personal finance bloggers who freely share monthly updates on their personal net worth, or their debt load, or both. I think this is brave of them, but from my perspective it can be a little dangerous for their readers. The temptation, of course, is for the reader to compare their net worth, or debt load to the the blogger's reported figures. This can take them down two equally detrimental paths. Either the reader is better off than the blogger, and feels a little smug; or the reader is in much worse shape financially than the blogger, and feels depressed or hopeless about his or her situation, and possibly envious of the blogger. Neither of these reactions is useful for the reader who wants to maintain a frugal lifestyle. In my experience, comparing one's own financial situation to someone else's is rarely profitable.

On the other hand, the benefits to the blogger are obvious. Making a practice of posting a monthly or quarterly update on your own finances is a good discipline that will, one hopes, keep you honest with yourself. The key difference here is that the bloggers are comparing their current financial state to their own previous financial states. Comparing yourself to yourself is extremely useful as it lets you track progress and can provide plenty of motivation. Monitoring your finances in this way also makes it much easier to set a series of short term goals, increasing your chances of reaching your overall goal sooner.

But I'm going to take the argument one step farther than that. If your finances are such that your assets include stocks, your net worth is subject to the rise and fall of the stock market. And there's almost nothing that you can do about that other than invest as wisely as you can. So my suggestion is to watch that number, but largely ignore it for the purposes of a monthly or quarterly calculation. Leave it out of your calculations altogether. Instead, focus on your total debt. That's the number that you have the most direct control over. If you're living within your means and practicing frugality, that number should, barring something like a house purchase, always go down. The lower the number, the better you should feel.

If your income and living expenses are relatively stable, over time the month-to-month reductions in your debt should get larger and larger. I remember when I was in my early twenties and I decided to get out of credit card debt that I actually looked forward to making my monthly payments. Because it meant that my balance was going down, and that next month I'd be racking up less owed in interest. I feel the same way now about our mortgage. I feel good when I'm able to scrounge up a few extra dollars to send off to our lender, no matter how small the amount. Getting to nothing owed on my credit cards felt FANTASTIC. I think it'll feel even better when we get to that point on our mortgage.

So set up a simple spreadsheet for yourself, and create a graph that shows your total debt going down, down, down. When you feel like you've had it up to your eyeballs with frugality, or when you look ahead and see only years of obligatory financial discipline in your life, turn back to that graph and think about the progress you've already made. Your actions, and efforts, and way of thinking about money have already made that much of a difference. Each payment you make cuts down on the interest you'll pay in the future. Remind yourself that steady progress is real progress.

For extra motivation, run some additional calculations. Keep a separate graph of the amount of interest you're charged each month. Or see how much more of your standard payment is being applied to principle from month to month. You can watch those numbers shrink or grow for extra cheer.

Our 12-Month Mortgage Reduction Goal

Right now my husband has a very well paid job. But it's a contract job and the contract will end a year from now. After that, chances are very high that he will take a substantial paycut, possibly as much as 50%, though we hope it won't be that severe. We're very fortunate that his current salary is high enough that even half of it would be enough for two frugal people to live on comfortably in our part of the country. But going from a great paying job to a decent paying job is always an adjustment.

Knowing this, we've devised a game plan for the next year. With a significant amount put away for retirement, and no debts other than our mortgage, we're well situated for reduced financial circumstances. Still, less than two years into the 30-year term on our mortgage, the remaining principle owed is over $200,000, and that's with some extra principle payments already made. Our goal then is to throw every extra penny that we possibly can at our mortgage over the next year. Specifically, we want to knock an extra $50,000 off the principle, over and above what would be paid down by our obligatory monthly payments. Let's look at the mechanics of how this is would work.

A simple division of $50,000 by 12 months gives us an additional monthly payment of $4167. Ouch! That's a hefty chunk of change, and an ambitious repayment plan by any measure. We know this is a difficult goal, and we recognize that we may not succeed, though we're certainly going to try our best. Because of the way mortgages work, we don't quite have to come up with that much money each month in order to meet our extra $50k principle reduction goal. But this early in the term of our 30-year mortgage, most of our regular monthly payment is still going to interest. So we don't see the power of compounding working in our favor very much yet. Still, as we make each extra monthly payment, a larger and larger portion of our regular monthly payment (about $1450) will be applied to our principle balance, instead of interest.

Our lender has a nice amortization calculator on its website, with all our information automatically calculated. If your lender doesn't have an automated calculator on their site, you can find one that anyone can use here. You'll have to enter the details of your own mortgage though. We used the calculator to figure out what our balance would look like a year from now under a few different payment plans. With no additional payments at all, the reduction of our principle balance after one year would amount to just $4000. With an additional monthly payment of $4167, our principle balance would go down by $55,700 after one year - just slightly more than our goal requires. (Remember, our goal is an additional $50,000 reduction. So the total reduction needs to be around $54,000.) To find the "sweet spot" - the lowest monthly amount that would let us reach our goal, I plugged in various amounts for the additional monthly payment, narrowing in on that total reduction of $54k.

After a little trial and error, I found that we could meet our goal with an additional monthly payment of about $4050. That's still quite a lot of extra money to come up with each month. In fact, it's about half of our net monthly pay. We have enough breathing room in our monthly budget already that we can fairly easily come up with $3400 per month to contribute to this goal. The remaining $650 per month is going to be a real stretch for us though. There's a strong temptation on my part to raid our cash emergency fund to achieve our self-imposed goal. That $12k currently sits in a relatively high interest savings account, so that it's easily available to us at any time. But even a high interest savings account doesn't match the interest we're paying on the mortgage. The math suggests we'd be better off putting that money towards debt reduction. However, that would leave us without an emergency fund, and vulnerable to increased debt if we run into an unforeseen financial crisis. So, as tempting as it may be, we're leaving that money where it is.

The obvious adjunct to paying more money each month is to try to secure a lower interest rate through refinancing. I tried this recently and we were turned down, even though our credit rating is excellent. Partly this is because we already have a fairly good interest rate, and partly because real estate values have taken a bath since we bought our home. According to the loan officer I spoke with, the automated value now assigned to our home is $33,000 less than we paid for it. We could contest that evaluation by paying for an individual appraisal. But even then we might not secure a better rate of interest. So for now we sit tight. But I'll be keeping an eye on interest rates. If it looks like we could get a better rate, we'll definitely try again.

Our purpose in this plan is threefold. First and foremost, we want to get out of debt as quickly as possible. Secondly, by devoting so much of our take-home pay to this debt, we are in a sense preparing ourselves for the day when that money is no longer available to us at all. In other words, we're training ourselves to live on a much smaller monthly budget. Thirdly, by reducing our principle balance and increasing our home equity, we're positioning ourselves well for refinancing our mortgage or even taking a home equity loan somewhere down the line, if we should need it. The home equity loan scenario is a likely one, as we would eventually like to build our retirement home. The money for that construction might very well have to come from the equity in our current home.

A year from now, we may have to go back to making just our minimum monthly payments on the mortgage. But whether we succeed in our ambitious goal or not, we will have made a significant dent in our principle balance, and a larger portion of each of our regular monthly payments will be applied to our principle, instead of lining the coffers of the lender. We won't feel like losers if our principle reduction over the next year is "only" $45,000 rather than $54,000. Instead, we'll feel a sense of satisfaction that $600 of our $1450 monthly payment is being knocked off our principle rather than the $360 it would be had we not attempted this goal at all.


Note: I posted an update detailing our revised approach to this goal.