Benefits of creating a zero-based budgeting plan

Zero-based budgets are an effective way to allocate your resources based on your own individual needs. Understand how they differ from traditional budgeting plans and how to create your zero based budget so you can take control over every dollar you spend.

What is Zero Based Budgeting?

Zero based budgeting involves documenting and assigning every dollar of your monthly income. The concept forces you to assign all of your money to either expenses or savings until your total income minus your expenses equals zero. The primary goal is to spend your money on paper before you actually spend it. If you end up earning more during the month, you can redirect money to your savings instead of spending carelessly.

Setting Up Your Zero-Based Budget

The first step to creating your zero-based budget is preparation. You will need to get out all of your statements, pay stubs, recurring bills, and records of other forms of income to set up your monthly budget. If you use checks to pay your bills, your check register will quickly become your best friend.

Once you gather all of your records, start by writing down all of your sources on income for the month. This can include employee income, income from rental investments, alimony, child support, or anything else that comes in regularly.

After you calculate the total amount coming in, you will need to write down a list of all of your regular expenses. Expenses include everything from insurance payments and your mortgage to clothing and entertainment. If a special occasion is coming up like a birthday or anniversary, make sure to include this in your list.

Once you have created your lists you will need to identify your expenses as fixed or variable. After the expenses are categorized, allocate funds from your income for fixed expenses first. Once you have allocated the fixed expenses, move onto allocating funds for variable expenses. Calculate the difference between your expenses and your income. If you have money left over, the purpose of zero-based budgeting is adjusting expenses until your income equals your expenses.

One of the primary benefits of creating a zero-based budget is learning how to save without spending money frivolously. You may be able to identify areas that are of less importance that you can even do without and eliminate from your budget. If you have a positive difference between your budget and your income you can use the extra money to pay down debts, save for retirement, create a vacation fund, or save for large purchases.

Creating a realistic budget and then sticking to it does require some work and effort. What I have found is that it actually reduces my stress when I know exactly where my money is going while at the same time allowing me to cover my expenses, pay down debt, save and also to spend money on things that are important to me.

Is It Better to Use 401K Funds or Secure a Second Mortgage?

When I bought the house that I currently live in, I decided to use a second mortgage in order to avoid PMI. You may be wondering though whether home financing or withdrawing from your retirement 401k is better, there is not one right answer. The answer to this question depends on what the current rates are for second home mortgages, how much you would pay monthly for private mortgage insurance, and whether or not you would be penalized for withdrawing from your account.

Retirement savings accounts are designed to be used for retirement. Using your 401k may save you money now, however, choosing to withdraw as an alternative down payment source will cost you quite a bit of money. Not only will you forgo the earnings you would have made from the money withdrawn, you will pay taxes and penalties based on the amount of money you withdraw. The IRS does classify paying for a down payment on a home as a “hardship withdrawal”.

Before you turn to this solution, calculate how much you will be penalized and how this may affect your taxes and the performance of your 401k.

Alternatives to Withdrawing

If you can avoid withdrawing from your 401k it is strongly recommended. Another approach to withdrawing is borrowing against your 401k. You will need to check with your employer to see if they permit account borrowing. If they do, you pay a low interest rate on the loan but this interest goes back into account. Technically you are taking a loan out from yourself and paying yourself back. You will not have to worry about taxes because the money you receive is not taxable.

Wise investors look for creative ways to fund their large purchases. I think that saving for a down payment is still the best solution as I wouldn’t want to touch the money in my 401k. However, if you are considering the benefits of using your retirement savings to buy a house, consider borrowing instead of withdrawing. Make a wise move that will help you long-term.

Financing the property
I was able to find a lender who would allow me to purchase the property with a 10% down payment. I had some money in savings but I got this brilliant idea to finance the property 100% with no cash coming out of my pocket.

Put equity to work – what some experts say to do
What I did was simply take out a home equity line of credit (heloc) and borrowed against my primary residence. I thought that this was a great idea. The equity that I have in my home is just sitting there – not providing any income at all. Why not use the equity as a down payment for something that can provide income. Made sense at the time.

Somethings are just better on TV infomercials
Buying a house with no money down puts you as the borrower at greater risk unless you are able to buy the house that is priced far under appraisal value. So, in effect what 100% financing has done is made my margins so tight that there isn’t much cash flow at the end of the month – even with a duplex. So, when the inevitable hot water heater goes out I may be forced to tap into my own savings to cover the cost.

Now, I know that this is not really a no money down situation but it was to me because I didn’t have to come up with the cash in order close on the property. Typically, when you hear no money down you’ll hear fancy finance terms like seller carry back or wrap around financing (more on these in later posts).

Lessons learned

Amount financed is key
I love real estate but I won’t buy another property until the entry point (price) is advantageous as compared to the rental market in the neighborhood. In other words, the property will easily cash flow each month. Which requires better negotiation tactics, market research, tenant selection and of course a much larger down payment. Because you are locked in for a period of time – 15 or 30 years, the financial terms of the loan are absolutely critical. All of these things were admittedly glossed over on my part this go around.

I am no expert
It showed that I was an amateur investor. It tested my ability to truly assess the property’s value as well as the ability to rent it out in order for it to cash flow each month. A bad idea for a first time rental property investor.

Borrowing against your house is crazy
What I know now is that using my primary residence as collateral substantially increases risk and expenses – and added to my debt load. I can only charge so much rent and still keep the rental occupied but due to the fact that I have pretty much financed the selling price.

Using my home’s equity was a mistake but…
I don’t regret buying the property. There is definitely something rewarding about having another property that provides income and the experience was priceless. I’m learning how to think in terms of a business owner by calculating monthly income statements and balance sheets. However, if I had to do it over again I would make sure that I had more down payment in order to reduce my expenses each month and not add additional risk by borrowing against my house.

Car loans = bad. Buy used.

I am of the position that getting a car loan is generally a bad idea. Cars depreciate in value and the payment can make up a significant part of your budget. To further drive this point home I feel that getting a car loan after bankruptcy is not only a bad thing to do but can throw you right back into the same situation that you have removed yourself from – in debt.

I filed bankruptcy, now what

If you have filed bankruptcy then it is time to move on. You did what you thought was best. However, keep in mind that it is what you do next that is the important point to consider.

After you file bankruptcy and the bankruptcy is discharged, you may start to receive several different loan offers from lenders eager to give you a car loan. Filers who have had their credit slate wiped clean are extremely attractive to lenders. Not only do recent filers have no debt, they also have a scarlet letter on their credit that gives lenders the green light to charge ridiculous amounts in interest. Make a wise decision and truly understand the consequences of getting a car loan after filing for bankruptcy.

High Interest Rates

Car loans for individuals who have recently filed bankruptcy are commonly called sub-prime loans. Sub-prime loans carry more risk which gives the lender an opportunity to charge higher interest rates. Some individuals will leap at the chance to get a new auto loan once they have filed bankruptcy. When you do this, you are letting anxious lenders take advantage of you. You are the perfect risk for their company. Knowing you have just filed bankruptcy, they know that you cannot file again for at least 7 years. This certainty, combined with the fact that lenders can charge 20 percent of more in interest, is what makes sub-prime lenders profitable. If you calculate how much you will pay over the life of the loan, you will see that you truly do not need the new car smell that bad.

Limited Vehicle Selection

Sub-prime lenders can approve or deny your loan based on the year, make, and model of the vehicle you are trying to finance. You may have your eyes on a new 4-door sedan and the lender may see you in a used compact. Having a recent bankruptcy on your credit report limits your options. If you really want a car, you are willing to settle with a car you may not have chosen otherwise. If you can, delay getting a car loan until you can get approved for what you really want.

Getting approved for a auto loan after bankruptcy is far from difficult. The main factor you should consider is do you really need a new car? Your current car has gotten you through tough times. If you have a reliable car, save up money and start to re-establish your credit so that you can get begin to build a strong financial foundation once again.

Generally speaking, the IRS will raise 401k contributions each year based on inflation. In 2010, the maximum contribution for the year was $16,500. While many investors expected this limit to increase a bit, the lack of inflation throughout the nation has affected the upward trend of maximum 401k contributions. The current maximum contribution has remained the same in 2009, 2010, and now 2011. The last increase in yearly contributions was in 2008 when the limit was increased from $15,500 to the current $16,500.

It is important to know the difference between a traditional 401K and a SIMPLE 401k plan. If you have a SIMPLE plan, your maximum contribution limit is quite a bit lower. SIMPLE plans have a limit of $11,500, which has remained the same in 2010 and 2011. Make sure to sit down and speak with the institution monitoring your account to see whether or not you have this type of account.

If you are age 50 or older, you can take advantage of special catch-up contributions to fund your 401k. Anyone who qualified for catch-up contributions can deposit an additional $5500 into their 401k account in 2011. Account holders with SIMPLE plans can deposit an additional $2500 into their account if they turn 50 before the end of the calendar year.

Many individuals are not aware of compensation limits. If you are contributing to an employer-sponsored plan, you cannot make more than $245,000 per year. All contributions may not exceed more than $100,000 of your compensation. These limits may vary with non-taxable and taxable income.

It is important to stay on top of your 401k. If you have asked what is the maximum 401k contribution per year, don’t hesitate to seek out the answer. Contact your investment institution or plan administrator and make sure your 401k is being funded properly to avoid penalties and required early withdrawals.

What is an HSA?

Before you can review health savings accounts you should have a basic understanding of what an HSA is. A health savings account is a tax-advantages savings vehicle that allows people to save to cover future medical expenses. To take advantage of a Health Savings Account you must be enrolled in a High Deductible Health Plan. The minimum qualifying deductible for a single person is $1100 and families may have a deductible of $2200 or more. HSA’s have become increasingly popular as Americans purchase higher deductible plans to reduce the cost of their traditional health care insurance. Now that you understand what exactly an HSA is, educate yourself on the pros and cons of these tax-advantaged accounts.

HSA Pros

One of the main benefits of HSAs involves taxes. While you are technically putting away from a rainy day, you are also savings hundreds or thousands of dollars in income taxes. This is because all of the contributions made to an HSA are tax-deductible. When you place income into a tax-advantage account you write-off 100 percent of all contributions made. This means that you can lower your taxable income and still have the money available in an emergency. While this is enough for some to open an HSA, there are other benefits as well. Any money in an HSA that is not used towards medical expenses grows tax-deferred like a Roth IRA. When account holders reach 65, they have the option to withdraw their money without paying any taxes or penalties. With HSAs, you get peace of mind in knowing the money is there now while still hoping you can wait until later to use it.

HSA Cons

One of the biggest disadvantages of HSA vehicles is the fact that you have to have a High Deductible Plan to qualify for it. While this may sound like a disadvantage, to some it is not. Many budget-minded consumers would rather save money on their health insurance premiums by taking the risk of having to pay a higher deductible. You should also consider the annual contribution limits set each year. Currently, the contribution limit for an HSA is $3000 for individuals and $5950 for families. Individuals 55 and older may qualify for catch-up contributions much like an IRA.

HSAs are a great financial vehicle for individuals with High Deductible Plans. If you have a high deductible health insurance plan you should save in the event you ever need to use your insurance. One of the best benefits of an HSA is if you do not have to use it, you can carry it with you to retirement.

What is a 401k Plan?

A 401k is a company sponsored retirement plan that gives employees the opportunity to take a portion of their income and store it in a retirement account to earn tax-deferred interest. Employees can choose how much money is taken out of their paycheck weekly, biweekly, or monthly, up to the limits specified by contribution limit laws. In 2011, the contribution limit for 401k plans was listed at $16,500. Employees contributing to a 401k at age 50 or older are allowed catch-up contributions. What this means is qualifying account holders can contribute an additional $5500 per year into their 401k account until the age of 65. All contributions are made from income before it is taxed. This is a major incentive for individuals who want to lower their taxable income and save for retirement at the same time.

How Does a 401k Work?

Most companies offer the option for employees to contribute to a 401k retirement savings plans. While some companies will match contributions, employees must be vested in their company for 5 to 7 years to receive the matched contributions the employer has made. Most 401k plans are administered and monitored by a third party or an independent banking institution. When an employee signs up for an employer sponsored 401k plan, he or she will select how much money should be deducted from their check. This fixed amount will go straight into the 401k account and will start to earn tax-deferred interest each month. 401k plans are financial instruments that are invested in the market. Institutions make conservative investment moves with this money and will invest in less risky mutual funds, money market vehicles, bonds, and stocks. The account holder has the option to withdraw from his or her 401k when they hit 65 without any tax penalties. Interest earned on a 401k may be taxable if it is withdrawn before the age of 65.

A 401k retirement plan is a great long-term savings plan that gives employees a way to save money without ever seeing it. If you are ready to start planning for your retirement do your homework and understand what is a 401k plan and how does it work. See if your employer matches contributions and calculate how much you can afford to put away for your retirement.

The front, or the first number in your DTI, is the percentage of your gross monthly income that goes toward housing costs, insurance, taxes, and homeowner’s associations fees. The back ratio will include housing costs and all consumer debt. Most DTI calculations are written in a fractional format. The first number will be the front ratio and the second will be the back. The back number will always be higher because it includes all types of consumer loans.

A common guideline for DTI’s to qualify for a home mortgage is 33/38. This means that 33 percent of the borrower’s gross wages are applied to housing costs and 38 percent of their wages are used to meet consumer loan obligations. While this is a common guideline, not all lenders follow it. Some lenders will be stricter on their guidelines depending on the borrower’s credit history and income.

If you know your lender’s guidelines, you may want to learn how to calculate debt to income ratio figures before you apply for a home mortgage. Each time you apply for a mortgage it is a hard hit on your credit file. If you know for a fact that your ratio is too high, you can work on paying down debts to qualify for a mortgage before you are denied.

There are several DTI calculators available for use on the Internet. If you are a numbers oriented individual, you may prefer calculating your ratio by hand. To calculate your ratio by hand you will need to jot down your monthly housing debt. This will include principal mortgage payments, interest, private mortgage insurance, property taxes, and association fees. Once you have totaled this figure, total your monthly gross income including wages, alimony, child support, overtime, and other income. When you have both figures, divide your debt by your income and multiply the number by 100. This is your front number. To calculate your back, you will do the same but you will need to include housing expenses, car loans, student loans, and other consumer debt.

The healthiest debt load is 36 percent or less. If you have a high debt load, you may not qualify for a home mortgage. Discuss guidelines with each lender and calculate your debt load before you apply. If you have a high debt load, you may want to consider reducing your debts before you buy a home.

Both investment accounts have the same annual contribution limits of $5000 per tax year and an additional $1000 for contributors who are 50 years of age or older. While contribution limits are the same, this is where similarities stop. The primary difference between Roth IRA and traditional IRA accounts comes down to tax deductibility. Traditional IRAs are tax deductible and can offer taxpayers a nice write off during tax season because the contributions are paid with after tax money. Roths, on the other hand, are not tax deductible. This is because account holders choose the power of tax-free growth over tax deductibility annually.

As previously stated, Roth IRAs give contributors the power of tax-free growth on their money. Generally, on an IRA, distributions are considered regular income and are subject to taxation in the same way regular income is. This means that during retirement your retirement distributions will be taxed because you were able to write them off during the years you were employed. Moreover, traditional account distributions may also be subject to early distribution penalties depending on when you request your money. Roth investment account distributions are completely tax and penalty free if you meet specific requirements. These requirements include distributions taken no earlier than 5 years from the first time the account was funded and distributions taken out because of qualifying extenuating circumstances including disability.

Before you decide which account is right for you, you should also consider contribution age limitations. For a traditional account, anyone over the age of 70.5 cannot participate in contributing to their account. If you plan on continuing to save for your retirement into your 70′s you may want to consider the benefits of the Roth IRA if you qualify. The difference between Roths and traditional IRA accounts in terms of age is that the Roths have no age limitations.

Roth IRAs do have income limitations for single account holders and married spouses. If you fall within this income limitation you should consider the advantages of taking out a Roth IRA. Most financial experts will recommend going with Roth retirement accounts because you should expect your tax rate to be higher in retirement as your earning potential grows with experience. Being taxed earlier means you will pay lower taxes over time. If you think you can benefit from writing off retirement contributions before retirement you may want to consider a traditional IRA.

Research the difference between Roth and traditional IRAs and see which benefits outweigh the others. However, the single biggest thing for you to do is to simply get started.

Higher interest rates
The theme of the day for automobile loans is in-house financing. This means that dealers will provide the potential borrower a network of lenders that will guarantee approval based on certain conditions. The most obvious condition is paying an extraordinary high interest rate. Many times consumers are faced with the fact that they will have to pay interest in excess of 25 percent or more on a simple auto loan. This can increase the monthly payment upwards of two to three times higher than what one might pay through a traditional bank loan. Another condition is coming up with as much as 20 percent down on the original principal balance of the loan. If one is unable to pay that amount down, they must produce a trade-in that can appraise at a minimum of 20 percent of the principal. Although the trade-in value may be worth much more than that amount, the consumer can fully expect only to get the 20 percent value.

Exorbitant fees
Car loans for bad credit borrowers face more than high interest rates and down payments. Fees associated with the loan can be three to four times higher than traditional financing. Not only is the consumer subject to high fees, late payment penalties are extremely stiff. Instead of the traditional five percent that banks charge when a payment is late more than 10 days, in-house financiers will charge up to 20 percent of the original monthly payment. They generally do not allow for a 10 day grace period either, but expect payment precisely on the monthly due date. This can lead to a tremendous amount of stress for the consumer who may face the possibility of repossession by simply being late a few days on one payment. This is so important to keep in mind if one is considering using a dealers financing network.

Manage your credit score
The best defense against having to get a car loan with bad credit is to keep control of your credit score. This point cannot be emphasized enough, and there are proven techniques that will help boost a score prior to a car loan search. Keep in mind that any median score below 580 is considered to be a poor score. Anything above 720 is widely regarded as a good score. Any score that falls within these two scores should allow one to obtain financing that is both affordable and secure.

Their are other ways to buy a car with bad credit. Before buying that shiny new vehicle, consider looking at reliable used cars that will allow you save more money while still providing a means of transportation.