By Trevor Hammond
When it comes to planning your mortgage, the first mistake people make is not realizing that the real discussion must first be about money. More specifically, cash flow. “We live lives of cash flow,” is something I say nearly daily in educating homeowners and in training my Advisors to be the most valuable mortgage professionals on the planet. Whether you are preparing to buy (and finance) a new house soon, or already own a home with a mortgage, here is a simple yet powerful formula to follow as money flows in and out of your bank account.
1. First Priority: Establish Your Cash Reserves:
Sometimes referred to as emergency funds, this is a sum of money that acts as the foundation for your financial safety. The best place to usually store Cash Reserves is in a savings account. Interest rate is not the most important factor for this money. Rather, safety and liquidity are…meaning, will the money be there when I need it and can I get to it fast in the case of an emergency. Set a target or goal for how much you would like to have saved in your Cash Reserve account, and start putting your first dollars of savings toward this. For some, this may be three months of your living expenses or six months of your income. Whatever it is, agree with your spouse on an amount that you both will feel good if achieved. For example, if your goal is $10,000, then any extra cash goes into this fund until you reach $10,000. If you allocate $200, or $500 per month in your budget to save, then that first goes to fund your Cash Reserves.
2. Second Priority: Pay Off Consumer Debt:
Once your Cash Reserve goal is met, start attacking that consumer debt! The temptation will be to pay down the debt first, since the interest rates are higher. The problem with putting too much money toward eliminating consumer debt before you have sufficient savings is that “life” will happen. Just as you get close to paying off that high interest credit card, your transmission will go out. Without the savings, you’ll be forced to charge back up your credit card that you just worked so hard to pay down. Thus, if you have $500 available each month, and your Cash Reserves are in place, then begin paying extra toward either the smallest debt or the debt with the highest interest rate. It is typically best to NOT spread the $500 across multiple debts. *For a complimentary RepaySMART Review™ from our Aspire Team, just call or email! Our planning software will help you map out a plan to pay off your consumer debt in the fastest, easiest possible way utilizing the Debt Snowball strategy.
3. Third Priority: Build Your Liquidity (Savings and Investing):
With your Cash Reserves in place, and your consumer debt out of the way, it is time to super-charge your savings. Hopefully along the way you’ve already been contributing to an employer retirement account, but if not, start there. Talk to your financial advisor, or contact us for a trusted referral. Building Your Liquidity can mean saving for your children’s college, increasing your retirement contributions, and even saving for the next year’s vacation so you can pay cash and not charge it. Remember, the real money game of life is ‘net worth’. All of your decisions should be focused on increasing your personal financial safety, and then growing your net worth. Think how nice it would feel to have a year’s worth of your expenses saved up.
4. Priority Four: Pay Off Your Mortgage
This is a tricky one. Helping families finance their homes for nearly two decades now, I have seen a lot of mistakes on this level. Rather than go too far into depth in this article and to keep it from getting too long, I’ll leave you with the key to this strategy: pay off your mortgage only after the first three priorities are taken care of, and you’ll find yourself in the home that you look forward to retiring in and being mortgage free in.
I hope this Cash Flow Priority Model helps. It is a simple, but very effective model we give to our clients that helps them long after the mortgage closes and they’ve moved into their new home.