Or do you say “that’s ok” and perhaps think “I want the points”?

In this month’s Mens Health magazine (May issue) I’m quoted in an article on how to make good use of your Qantas frequent flyer points. Several of the tips I’ve covered in my earlier article here.

One tip that didn’t fit into the Mens Health article was that paying a credit card surcharge is often not worth the reward points.

Credit card surcharges

Most credit card surcharges are over 1% of the transaction amount. So for every $100 you pay at least an extra $1.

In fact the average surcharge is much higher than 1 per cent. According to a East & Partners’ survey reported by the RBA, “in December 2010, the average surcharge for MasterCard credit cards was 1.8 per cent, for Visa it was 1.9 per cent, for American Express it was 2.9 per cent, and for Diners Club it was 4 per cent.”

Value of a Qantas Frequent Flyer reward point

As I mentioned in my earlier article each Qantas frequent flyer point is only worth about 0.69 cents. That reward therefore is equivalent to about a 0.69% discount.

Deciding if you will pay the surcharge

If you earn 1 reward point per dollar and the credit card surcharge is 1% then you are paying an extra dollar and only earning 69 cents back. By paying with your credit card you just lost 31 cents.

If you earn 2 reward points per dollar then the surcharge needs to be less than 1.38% to make it worth handing over your credit card.

At many retailers you’ll need to be earning 3 reward points per dollar to make the surcharge palatable. Points are usually only that high for retailers aligned with the credit card issuer.

Often when faced with a credit card surcharge you are better off handing over your EFTPOS card and paying from your savings account. (That’s better for most people’s budgeting too.)

Next time you go shopping carry both cards with you.

You may also enjoy these related articles:

1. Budgeting tip: Medical costs
2. The New American Money Math
3. Budgeting tip: They don’t make things like they used to

What a waste!

Back then it was a common complaint that reward seats were scarce and never when most people wanted to fly. Ten years on reward flights are easier to come by and you can even use points to partially fund a flight.

And there has been one other excellent development.

You can now cash in your frequent flyer points!

The Qantas Frequent Flyer Store currently includes 214 gift vouchers. The vouchers that excite me the most are the ones for everyday essentials like groceries, fuel and clothes.

The best value gift voucher I have found is just 13,500 points for a $100 voucher. This rate applies for many of the retail stores, such as Big W, Myer and Adairs, and also for car hire, hotels and Qantas Holidays.

Most other gift vouchers for Woolworths Group stores cost 14,500 points for a $100 voucher. That means your points are worth about 0.69 cents each. (Yes, less than one cent per point.)

Flights or gift cards?

Yes, redeeming your points for a flight award may offer slightly better value depending on when you fly. However if you usually fly only on cheap fares and specials then you’ll probably find, as I have, that the savings are about the same.

By redeeming your points for vouchers you can reduce the impact of rising costs. And, if you’re on the ball, you should therefore be able to boost your cash savings.

Even better, if you direct those savings into additional mortgage repayments you will be able to own your home sooner. Awesome!

When weighing up whether to accrue your points for flights or redeem them for cash keep this in mind – you don’t earn interest on your frequent flyer points.

In fact it seems that even though flight prices haven’t increased much the amount of points required has increased. So the value of your award points is actually decreasing.

Getting started is easy

With just 3,750 points you can redeem a $25 gift card. So log on right now and start redeeming.

Automate it

Qantas Frequent Flyer has recently introduced Auto Rewards. You can elect to automatically redeem your points for a Woolworths gift card every three months.

The current maximum amount is a $20 gift card costing 3,000 points. (That’s a value of 0.66 cents per point.)

Worried about security?

Yes gift cards are cash-like so you are right to give some thought to security.

At the very least you should have a decent padlock on your mail box to help protect yourself from identity theft. That will also help against theft of your gift cards.

Alternatively use a post office box – either your own or where you work.

Take the pressure down this Christmas

There are gift vouchers that will cover most items that will hit your budget this Christmas, including gifts. From general retail stores to travel, auto, hardware, electronics, food and liquor.

You may even decide to just give the voucher to someone as a gift. Hmm, that gives me an idea. I might redeem some points for a Bunnings voucher for my father-in-law.

You may also enjoy these related articles:

1. How to easily save 5% on your groceries
2. Avoid the Christmas and New Year Debt Hangover
3. Would you like a cheap holiday?

Medical expenses are included under the category of “irregular expenses” in my budgeting approach. You save a regular amount each pay period into a dedicated savings pool from which you later draw when the expense occurs.

If you’re just setting up your budget and haven’t been tracking your expenses for the past year you can get an initial estimate of your annual medical expenses from a combination of these sources:

• Medicare online – allows you to download past 12 months and shows you net out of pocket
• Your private health insurer –  online access or just call them
• Past credit card and bank statements

As you complete your tax return this year you may need your Medicare claims history. Keep this information each year and over time you’ll get better at estimating your medical expenses.

Yes, sometimes you’ll have an unexpectedly costly medical bill. This can be covered from your budget’s contingency, which I’ll write about soon (so stick around).

View more budgeting tips or read the introduction to my Better Budgeting method.

You may also enjoy these related articles:

1. Budgeting tip: They don’t make things like they used to
2. Better budgeting
3. Are credit card surcharges worth the points?

Unfortunately electrical goods aren’t made to last that long, yet they’re cost is significant.

When an electrical good suddenly gives up you can be faced with finding a tidy $1,000 or so to replace it. For many people this causes unwanted financial stress and can result in them funding the purchase through debt or other savings. Neither of those options is ideal.

Funding through debt just increases the cost courtesy of the loan interest.

Funding from savings that were earmarked for something else is frustrating as it can mean you miss out on that  other thing you were saving more. Clearly that is not what you want in your life.

Save for the predictable

Next time your fridge, washing machine or TV goes on the blink there is no need for you to blow a fuse.

It is reasonably predictable that your household electrical items will need to be replaced during your life time.

The exact timing is uncertain but you can assume items will last about one or two years past the expiry of their warranty. That’s just how items are made these days.

Similarly the precise cost is unknown but it can be estimated. Just take the current replacement cost and increase it for inflation of about 3% per year.

How to save for replacing household items

Knowing the approximate time and cost you can then calculate the regular amount you need to save each month so that money is there when you need it.

Don’t worry about including interest on your earnings in the calculation. In fact for ease just assume the interest earned on the savings will offset the inflation.

Just use a simple calculation of replacement cost divided by months until money needed divided equals regular monthly saving amount.

If the item lasts longer or costs less than your estimate that’s a bonus. You then have some ‘spare’ cash you can use for those items that need replacing sooner than planned or cost more than planned. This budgeting strategy can have an in-built contingency.

Household items to plan for

For an idea of what items to save for just take a walk around your house, both inside and outside and note the significant items you would replace when they break down. The household electrical items include:

• Refrigerator
• Freezer
• Dishwasher
• Oven and cook-top
• Microwave oven
• Washing machine and dryer
• Television
• Stereo
• Computers and printers

View more budgeting tips or read the introduction to my Better Budgeting method.

You may also enjoy these related articles:

1. Better budgeting
2. Budgeting tip: Medical costs
3. The New American Money Math

The question

Hello Matt, my husband & I own our own home but have a mortgage of nearly $300,000. It is an equity style loan, we only have approx $30,000 of equity left to use.

We are paying interest only and those payments we are finding very hard to meet, we do have a credit card which i think is probably not a good idea.

We are currently a single income family with an income of around $62,000 a year gross. But we have approx $15,000. of business related outgoings per year, this figure can go up to $20,000 a year.

We also own a half of an inheritance property worth a lot of money but the other party doesn’t want to sell.

Our question is, is there a way given our current situation that we could manage to cut down our debt and start to pay some of the money off our loan without losing our home?

My answer

As I don’t know you personally I don’t know your level of financial knowledge, so in explaining my guidance I’m going to start from some base principles. Please forgive me if this seems like statements of the bleeding obvious – it is not my intent to be patronising.

Your priority in reducing debt should be highest interest rate debt first then cascade down to lowest interest rate debt. Therefore if you have a carry-over credit card balance you nail that first, then personal and car loans and finally home mortgage. Paying off your debts in the right order is a fast way to generate spare cash for further debt repayments.

At the core the ways to reduce debt are:

• Make lump sum additional repayments
• Make higher regular repayments

To be able to make higher regular repayments you either need to:

• Increase your earnings;
• Reduce your costs (spending);
• A combination of both of the above.

Some options to help you achieve that include:

• Crank the business earnings
• Get a second, even third job (Perth restaurants and cafés are crying out for staff so they can actually deliver decent service)
• Pull your belts in so you spend less. You may need a cash flow coach to support you in creating the new habits to do that. It is a bit like a personal trainer for you money.

My article on budgeting may provide some guidance on reducing your expenses.

You can make higher lump sum repayments by selling stuff you don’t need to generate cash. Or you could even sell other investments and repurpose them to debt repayment.

If you really think you are close to losing your home and if the only other wealth you have is the inherited property then you really need to either sell it or mortgage it. A mortgage it is probably not feasible as that’ll just increase your repayments. If you haven’t done so already then perhaps tell the other owner of the inherited property that if you don’t sell then you’ll end up losing your home. Maybe they could consider buying your share from you?

To get out of a financial pickle like this it really comes down to ‘what are you prepared to do?’ There is no magic rabbit out of a hat. You have to dig deep and hustle.

Once you sort out your cash flow then it’ll be more appropriate to consider a plan. Watch my free presentation on The Six Stages of Wealth Creation to get a sense of the right next steps from there.

You may also enjoy these related articles:

1. Seventy percent of credit card debt accrues interest
2. Increase your cash flow by managing your debts
3. 3 tips to manage your mortgage stress

I recommend you click through to read Carl’s article that accompanies the sketch.

You may also enjoy these related articles:

1. Better budgeting
2. Are credit card surcharges worth the points?
3. Budgeting tip: Medical costs

Given that annual fees start around $10,000 per year from early primary school that total figure probably comes as no surprise.

If however you are hoping to send your children to private schools let this be another nudge to ensure that you have detailed plans in place for how you are going to be able to afford that dream.

At the same time consider what safety nets you have in place. Do you really want to have to move your children to a new school away from their friends if you strike a tough financial patch?

Note that whilst I appreciate ASG publishing these figures I am not a fan of education bond products like those of ASG. I believe there are better ways to save up for and fund your children’s education. I believe funding school fees should be looked as one lifestyle goal (albeit a big one) as part of a total financial well-being plan. That can give you greater flexibility as well as better bang for your savings buck.

School fee summaries and estimates by state

ASG have kindly provided very detailed summaries, which makes their information worth a look.

You can browse national figures and by state. Figures are also split between metropolitan and regional and between education ‘systems’ (Government, Systemic such as Catholic, Private).

And they also include estimates for children starting pre-primary this year (2011) and those children born this year.

View the ASG school fee estimates here.

You may also enjoy these related articles:

1. Calculating the costs of your children’s education
2. Saving for your children’s education
3. Kids, they might be cute but they are costly

As I immersed myself in the insights there was one in particular, right at the very end that I read as a personal challenge. (page 285, 2009 revised edition, pbk)

Dan Ariely described how when he and his wife Sumi went to buy a house he asked some experts he knew “including a few finance professors from MIT and investment bankers” what seemed to him like a simple question.

It is a question you have probably considered too.

“How much should I spend on a house?”

Ariely describes how everyone told him the same thing – a way to calculate how much he could borrow based on his income and the interest rate. But that’s not the question he asked.

Ariely noted “when I tried to push for an answer, the experts told me that they had no way to help me figure out the ideal amount we should spend and borrow.”
(my emphasis)

Can you see why I read it as a challenge?

Well, I have the answer for you Mr Ariely (I hope one day I can call you Dan).

First, let me share Ariely’s behavioural conclusion from his experience:

“When we can’t figure out the right answer to the question facing us, we often figure out the answer to a slightly different question, and apply this answer to the original problem.”

Hopefully you can see the potential issues in that human decision making.

How much you should spend on your next house

The maximum price you should pay for your next house is the sum of:

• Your saved deposit
• Transaction costs
• The maximum amount you should borrow

The maximum amount you should borrow is a function of:

• the loan term
• the average interest rate over the loan term
• your maximum affordable regular repayment amount.

For definitions of the categories described in the formula below see my ‘Pay Yourself First (in practice)’ model I described in my recent article on better budgeting.

Maximum affordable loan repayment equals your net after-tax income, less allocations for:

• Regular saving for your financial independence goal
• Regular saving for pre-retirement essentials
• Repayment commitments on other existing debts
• Irregular expenses
• Regular essential and comforts
• Impulses and indulgences (presuming you’ll still want the occasional splurge)

Now you have estimated the ideal amount you should spend on repayments rather than some alternate rule-of-thumb like 30% of your income.

To estimate your maximum affordable loan amount you then plug that repayment amount into the free borrowing calculators provided by the lenders. Or you can do it yourself in a spread sheet using the present value (PV) function.

You can download an example calculation here.

Extra tips

By the way, don’t use what the lender says you can afford to repay each period. Their calculation ignores your need to save for eventual retirement and often assumes you can live a lifestyle equivalent to the Henderson Poverty Index (in Australia).

In completing the affordability calculation I recommend you:

• Choose your loan term to match the amount of years until your financial independence goal. That way your debt will be repaid by ‘retirement’.
• Add an extra 1% to the lender’s current interest rate to give you a buffer.

When you actually apply for the loan you can apply for the typical home loan term of 30 years and just plan to make extra repayments in line with your calculation. This technique also builds your buffer for if misfortune strikes.

In practice

Life is a balance between doing something that brings us immediate fulfilment and doing something else that is an investment in future fulfilment.

Exercise, healthy eating and study are often investments in future fulfilment.

If the type of home you really want to buy costs more than the above estimate you then need to make an informed trade off.

Are you willing to cut other elements of your current lifestyle? Or are you willing to cut your expectations of future lifestyle like holidays, car upgrades and retirement?

Please share your thoughts

What do you think of my recommended approach to this common dilemma? Please share your reflections in the comments below as I’d really like to know. (You can share under a pseudonym to protect your privacy.)

You may also enjoy these related articles:

1. Increase your cash flow by managing your debts
2. Qn: How do we get out of debt?
3. Six tips for choosing the best home loan

Budget…is not a…dirty word! Budget…is not a…dirty word!

Once on live TV I was challenged to come up with a better word for a budget. The interviewer felt the word was too creepy.

The reality, as you can probably guess is that it has nothing to do with the word but the meaning we associate with it.

In fact the origin of the word “budget” is in the leather case or wallet that bureaucrats used to carry their financial plans.

Of course the problem is that for many people budget conjures feelings of restriction. (Just like the word “diet”.)

A good budget should be the exact opposite. It should facilitate you having enough money for the things that really matter so you need not feel restricted.

You achieve this this by following the wealth principle I call “saving for the significant and minimising the insignificant.”

Pay Yourself First (in practice)

It’s likely you’ve heard of the principle to pay yourself first.

Back when I was a graduate engineer I thought this principle meant to put a certain percentage of my income away for wealth creation. Then I wondered “what next? How do I manage the remainder?”

Now that I’ve had the benefit of working with lots of people on their cash flow I’ve created this model to help you create an effective budget that sets aside money for the significant things in your life plan.

(Download a PDF version of the model here)

Top-down or bottom-up?

To follow the principle of pay yourself first ideally you work from the top as you allocate your income into pots of savings.

However, if you find that you never have any savings and in fact spend more than you earn the top-down approach won’t feel possible – because it’s not yet. To extricate your butt from the spending fire first you need to get control. You do that by starting at categories 5 and 6 and working upwards as you increase your control.

In short if you are in stages 1 or 2 in the Six Stages of Wealth Creation you would start at the bottom and work upwards to improve your cash flow management. Everyone else can take the planning approach and go top-down.

Your pots of money

1. Financial Independence

The first pot you allocate is how much you need to regularly invest so you accumulate enough net wealth to “retire” – or make work optional – when and how you want it.

In addition you include the additional regular loan repayment s you need to make to ensure you are free of personal (non-investment) debt by your financial independence target date.

2. Pre-retirement Essentials

The second allocation is to all the big things you want and need to do, buy or experience between now and the point you achieve financial independence.

For example: car upgrades, major home maintenance, family holidays, replacing major household items, parental leave. (The list goes on.)

In my experience many people find these items either blow their savings or are funded by debt. Why borrow and pay interest on predictable expenses when instead you could be earning interest? Earning interest in advance actually reduces the true cost of the items and the amount you need to save.

3. Irregular Expenses

In this pot I include all expenses you pay at least every year but less frequently than monthly.

For example: clothing, utilities, insurance, gifts, parties, subscriptions.

Again from my experience it is often the irregular expenses that end up blowing the savings of otherwise consistent savers. The problem for them is that whilst they are saving, usually by automated pay deductions, they are not saving enough. Month-to-month they may have savings but not year-to-year.

Often when clients actually separate their irregular from their regular expenses they are shocked by how high a proportion are irregular expenses. That observation alone is an insight into why they may be spending too much.

The expenses may be out of sight but they should not be out of budget.

4. Existing regular commitments

This category is the allocation for repaying all of your existing debts as per the current minimum required repayment.

For many people this is the first line item they put in when working out their budget.

The reason loan repayments is item 4 is that when you take a planning approach you first allocate items 1 through 3 to work out how much you can afford to borrow.

The way many people actually work out how much to borrow is a combination of:

• What the lender says they will lend them
• Their income less the regular spending that comes to their mind (i.e. untracked)

5. Regular Essentials & Comforts

All the regular items you spend at least every month.

When you take the planning approach you get to this point and discover how much you can afford to spend on comforts. And some things you thought were essentials get re-categorised.

It’s at this point many people start prioritising between lifestyle now and future significant goals.

• Which is more important to me?
• If I don’t save up for that future goal, but still want it how will I create the money to afford it? (e.g. I’ll only be able to afford X if I get a promotion – so I’d better start investing in professional development.)

6. Impulses and Indulgences

The final category is a little allocation for spontaneity.

How much to allocate to each pot

If everyone were identical in situation and value-system then we could define a nice neat package of percentages to allocate to each pot.

But we’re not.

To create a budget that is meaningful and motivating to you it needs to relate to your goals for your money.

That’s not as hard as it may sound. You already know what you want – it’s in your head, you probably think about it regularly. Just get it out of your head and onto paper and then put a number and time frame next to it.

Automatic wealth creation

Once implemented good budgeting should also be as automatic as possible. That’s the next step of smart cash flow management.

If you’re interested in how to put this all into place talk to me about Cash Flow Coaching.

You may also enjoy these related articles:

1. Budgeting tip: Medical costs
2. Budgeting tip: They don’t make things like they used to
3. Teaching Kids About Money

Now fixed interest rates are similar, even lower than the variable rate as shown in the table below. And while the RBA has recently softened its talk future rate rises seem probably to many – especially those living in boom regions. So fixing rates may be starting to look attractive to some.

Source: Cannex (accessed 20th April 2011)

History

The real problem with fixing anything for a time period is that you need to be very confident in the accuracy of your crystal ball. The last boom seemed to last long enough to affect people’s memory and lull them into thinking it would go on for much longer.

Inflation was getting uncomfortable for the RBA so rates had been up going up. That lead many of the boom-believers to fix their interest rates in the hope of beating the rises – sometimes for 3 and 5 years.

What transpired was much gnashing of teeth when interest rates plummeted, as summarised in the graph below of the RBA cash rate.

The consequence of an error-prone crystal ball can be very costly.

So should you?

For a detailed examination of the considerations in fixing rates read my earlier article. There are some circumstances when you would fix interest rates.

Right now include the following when contemplating your decision:

• The recovery is not certain. Rates may not move for some time. So if you fix your rate you may trade off flexibility for no benefit.
• Another sharp down-turn is possible. How will you feel if you’re paying a higher rate than the variable rate?
• The future gets increasingly uncertain the further out you project. Exercise greater caution when considering longer terms for fixing rates.

A personal observation

In my role as a financial planner I have seen how rapidly people’s life and goals change in just a few short years. For those who fixed their interest rates (before becoming clients) I’ve noted how the lack of flexibility has inhibited their money management and wealth creation.

Don’t underestimate how quickly life evolves.

If you’ve had some big changes in the last 3 years then maybe you also will in the next 3 years – it may just be the way you roll. So,  perhaps a 3 year fixed rate is not the best thing for you right now.

You may also enjoy these related articles:

1. To Fix Interest Rates or Not?
2. 3 tips to manage your mortgage stress
3. Six tips for choosing the best home loan