By Janine Starks*
Here's a letter I received recently from a young couple looking for advice:
I am constantly worrying and stressing about money and our future. We would like to start trying for kids in 18 months but would also like to work hard to get rid of some of our mortgage so we are not so stressed when we have the kids. We are recently married and in our mid twenties. I have an income of $32,000 before tax and my husband earns around $40,000. He gets quite a lot of overtime in the summer months.
We have just built a house and have a mortgage of $225,000. The minimum payment is $600.00 a fortnight, but at the moment we’ve been topping up to $900. We have spent a bit of money furnishing our house to try and make it look nice and have saved $7500 to build a fence and landscape. I’m worried about the financial pressure of starting a family – will it be too hard?
It’s a fact of life – babies cause big financial bumps as well as physical ones. Now you’ve admitted you’re a worrier you can breathe a big sigh of relief.
Because guess what? You are totally and utterly normal. It would be a very odd person who didn’t worry about the prospect of their income being almost halved, mortgage payments having to be made and bills rising with baby expenses.
The solution lies in some meticulous planning as that will dissolve the stress.
I won’t lie – oh course it’s going to be hard, but let’s put some perspective on this. You are only in your mid twenties, you are married and have built a brand new house. It’s a fantastic position to be in and one which many people in their thirties haven’t yet achieved. From your achievements so far it’s obvious you are planner and you make things happen.
When it comes to ‘planning’ I’m not just talking about number crunching. Be honest about your financial personalities.
Are you a ‘Tom and Barbara’ type couple? Or more of a ‘Margo and Jerry’? I’m showing my age, but it’s an analogy from the TV show ‘The Good Life’ which screened 35 years ago. You might have to google it. We all fancy ourselves as Barbara; growing veggies, chasing chickens and saving money. In reality, most of us err more towards Margo, the rather more materialist and well dressed neighbour.
Most women transform at different life stages. With a double income and no kids you’re currently in the Margo camp, but when the time comes for one income, financially you’ll be Barbara. As a couple you need to decide if that’s going to be a permanent transformation, or one that only lasts a year or two.
'Money isn't everything but it ranks up there with oxygen'
People love to tell you that money doesn’t make you happy, but that’s poppycock. There is a point where a constant lack of money is very stressful and depressing.
When it comes to a budget, you need to be honest about where that point falls for you. It’s going to dictate ‘if’ or ‘when’ you return to work.
Now for the numbers. The quick summary is that your income will disappear when you have a baby and your husband has a take-home pay of around $1260 a fortnight (let’s not include overtime for now). Your mortgage is $600 (although you are paying it off quicker at $900 a fortnight).
It’s worth checking with the bank to find out what the current minimum repayment is. Variable rates are about 6.2% at the moment. For a $225,000 mortgage spread over 25 years, your repayment would be $680 a fortnight ($80 more). Your calculation indicates a 5% interest rate, so I’d like you to double check that.
You need to run the numbers and see how much you are going to benefit by paying off the mortgage quicker and how sensitive the numbers are to changes in interest rates.
Add it up
There are some useful on-line calculators that will make the job easier for you. Check out interest.co.nz's mortgage calculator here or the one on Retirement Commission's website at www.sorted.co.nz . I ran an example that showed if you knocked $50,000 off your mortgage in the next 2 years, you would need to increase your repayments to $1300 a fortnight. That’s all of your husband’s salary.
It leaves your take-home salary of around $1,000 a fortnight to live off. This calculation assumes interest rates stay at 6.2%.
You would then have a mortgage of $175,000 in October 2012. If you had a baby at that time and stretched your mortgage back out to 25 years, the minimum repayment would be $530 a fortnight ($50 more if interest rates rise 1 percent). If we are conservative and assume your husband’s salary doesn’t change, it leaves $730 a fortnight for food and bills. You now need to do a budget to see how this would impact your life.
One of the things about doing a budget is that it never feels real. But you have time to do a proper trial run and see what it feels like for six months. You can play around with the numbers yourself, but in my example you’d need to live on $730 a fortnight.
Financial stress test a good idea
It’s much better to test where the tension would come in while you don’t have the added stress of a new baby. Do an income plan for a full year. Add in half the overtime and research the ‘Working for Families’ tax credit and ‘Parental Leave’ tax credit to see where extra income can be obtained. By ringing IRD they will work out what you are entitled to and there are calculators online.
An alternative planning method is not to repay the mortgage any quicker than you need to. You would stick to the minimum repayments and put all your extra cash into a ‘baby-fund’ (I just mean a savings account). You could start by re-earmarking your $7,500 fence-fund as a baby-fund.
Remember we all got bought up in an age where a washing line and a lone lemon tree counted as landscaping. At the moment your combined pay is around $2,260 a fortnight.
If you make the minimum mortgage repayment of $680 and have $1000 for food and bills, it leaves $580 a fortnight for savings. Over two years that gives you a nest egg of $30,000. Adding in the fence money, takes it closer to $40,000. Having that pot of money for big bills and emergencies during the years you have children will take away a lot of worries.
The third method is to do exactly what you doing now – a half-way house between two ideas above; get the mortgage a bit lower and do some saving. That might well be the right sweet spot for you. But to take away the worry you still need a proper plan.
Figure out where your mortgage will be in two years (my quick calculation shows $197,000 at $900 repayments), what the minimum repayment will be if you stretch it back to 25 years when you have a baby (around $600 at 6.2 percent interest, or $50 more if rates rise 1 percent) and how big your savings pot would be (it could be $18,000 if you can save $360 a fortnight for the next 2 years).
Good luck and enjoy the planning because there is an exciting reward at the end of it.
Email your questions to firstname.lastname@example.org, subject line: Financial Agony Aunt. Anonymity is guaranteed.
*Janine Starks is Co-Managing Director of Liontamer Investments. Opinions in this column represent her personal views and are not made on behalf of Liontamer. These opinions are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.