Get With The Plan: December 25, 2011

Mary and Kris started a family this year, and they’re trying to juggle the costs of a new baby with their other expenses. It’s not easy.

“We purchased a handyman home in 2008 and we need thousands of dollars of work to fix the home,” says Mary, 41. “We also want to get out of debt.”

The couple, with increasing expenses, is finding that hard to do.

They even stopped their 401(k) contributions and took out $2,500 from Mary’s plan to help cover bills when she was on maternity leave. The couple has $35,000 in checking and $4,000 left in Mary’s 401(k) plan.

The Star-Ledger asked Michael Pirrello, a certified financial planner with Mill Ridge Wealth Management in Chester, to help the couple get on track with a financial plan that will accomplish their goals.

“For young families in New Jersey, times are tough,” Pirrello says. “With this backdrop, the basic financial goals of saving for retirement and college generally take a back seat when families are finding it increasingly difficult to make ends meet.”

Pirrello says that while Mary and Kris were recently blessed with their first child, as all parents know, the joy of being a parent also means increased expenses. Child care for their baby is $1,200 per month in addition to the increased grocery costs — a big challenge to their monthly budget.

“This couple really does not have any frivolous monthly expenses, so other than being careful as to how they spend their discretionary dollars, they need to look deeper at longer term expenses to see where they can be more efficient,” Pirrello says.

He took a look at three action items that over time will make a big difference for this family.

First, debt. The good news is that they’ve saved $35,000 in a checking account. The bad news is their credit card debt exceeds $24,000.

Pirrello says they should start by paying off the credit card that has a $7,800 balance at 18 percent. The annual interest charge on that account is approximately $1,400 per year, which the couple can’t afford to pay.

By paying off this card from the checking account, they will save on interest charges and free up further cash flow by not having to make that monthly credit card payment, Pirrello says.

“The other credit card balances that the couple has are basically at zero percent interest rates for the time being, yet as those rates increase, those balances will need to be reduced as well to avoid an increase in interest charges,” he says.

They shouldn’t use all of the cash to pay debt because they need some in reserve for emergencies, preferably $12,000 to $15,000.

The couple’s mortgage is the second action item. Like many New Jersey homeowners, Pirellos says the couple has lost equity in their home so they’re finding it difficult to refinance. Their home is worth approximately $295,000 and their mortgage balance is $270,000, equaling a 92 percent loan-to-value ratio.

“Most lenders want an 80 percent LTV, yet there are programs that exist in which Kris and Mary may still be able to refinance,” Pirrello says. “Mortgage rates are at historical lows now. They should be aggressive and search out a lender that will refinance their 5.625 percent mortgage to a 30-year rate between 4.25 and 4.75 percent.”

If they were to refinance at 4.5 percent, their new payment would give a monthly savings of $421, Pirrello says.

The third item is a controversial one — long-term care insurance. At age 41, Mary pays $182 per year for a long-term care policy. Pirrello says long-term care insurance will help with care, if required, later in life. But for Mary, there are more pressing concerns.

“By paying off the high interest credit card, refinancing their mortgage, and dropping the unnecessary long-term care coverage, Kris and Mary may save approximately $550 per month or $6,600 per year,” he says. “This savings can be applied to pay down credit card debt and pay for the immediate home improvements that are necessary.”

The couple does need more life insurance with the birth of their baby. Kris has one year’s salary of coverage — $35,000 — through his employer, and he has an additional term policy for $50,000, for which he pays $368.

“Kris’ term policy seems grossly overpriced and he should look for a lower cost policy,” Pirrello says. “Standard 20-year term coverage of $300,000 for a 42-year-old male is approximately $550 per year.”

While that would increase expenses by approximately $182 per year, it is absolutely necessary, Pirrello says.

Mary has coverage worth one year’s salary, or $55,000, through work, and she also has a private whole life policy worth $35,000 of coverage. Pirrello says she’s also underinsured.

“Mary pays $450 per year for her current coverage. She should convert her current whole life policy to a 20-year term policy for $300,000 of coverage,” Pirrello says. “The approximate cost of that coverage will be $375 per year.”

While cash flow is an issue, this couple can’t ignore retirement savings. Pirrello recommends they restart 401(k) contributions at 5 percent of salary, which will also give them matching contributions from their employers.

“Eventually, as the couple pays down debt and accomplishes short-term financial goals, they should be able to increase their contribution amounts on a regular basis,” Pirrello says.