Some of the most important things in life are always taken for granted. In that regard, most of us drawing a straight salary don’t ever think about how fortunate we are to get a regular monthly or semi-monthly paycheck with consistent pay, especially as it relates to consistently paying our bills on time. But you can bet that people who work on commission and/or depend on tips for a significant portion of their income from month to month know all about the pitfalls that come with inconsistent paychecks.
This point was really driven home to me the other day when I got an interesting question from Anthony, who has a variable monthly income because he works on commission. In that regard, during slower months he was struggling with the best way to consistently save money for a down payment on a house and still pay all of his bills without having to rely on credit cards.
Before I explain a simple and effective trick for effectively managing personal finances when income fluctuates from month to month, let’s go to the mail bag so Anthony can explain his dilemma in his own words…
Len, I have been trying to save for over ten years just for a down payment on a house. Unfortunately in sales…there are months when you don’t hit your goal and get a very small paycheck. In that sense in order to not take money out of savings for everyday items I found myself charging for the things I needed. So with credit card debt and a decent savings…some would say I should pay off the debt with the money saved. This I understand, but if I did that then I would basically never be able to buy a house one day…I know you must be reeling over my decision to hold onto the debt a little longer. Hell, if need be…I’ll work two jobs even maybe three…Let me know your thoughts.
Anthony, I think the first thing I would suggest is you reconsider the purpose of a savings account. Savings accounts are, after all, specifically supposed to be there for you when you have months of less-than-expected income.
Credit Cards Are NOT the Answer
Although I do understand your concern about fluctuating income, using credit cards to fill the gaps is NOT the answer.
I hate paying interest, although I can make exceptions for homes, college and businesses. But one of my basic rules is this: If I can’t pay for something up front, or at least buy it on time at 0% interest and pay it off before the promotional period expires, then I will not make the purchase.
That should be your rule too.
So, before you do anything, retire your credit card debt and stop relying on them to cover any more occasional shortfalls in your income. Okay, Anthony?
A Simple Trick: Use Multiple Savings Accounts as a Means to Meet Your Goals
Judging from your letter, I am assuming you already have some decent savings built up. If that is true, then I believe a solution to your problem already appears to be well within your means.
To help smooth out your monthly income variations and still build up money for a home down payment without resorting to credit cards, why not establish and leverage the power of three separate savings accounts?
Here’s how it would work:
Savings Account No. 1: Paycheck Shortfall Account
This account would have one month’s living expenses to handle the shortfalls that would arise during the months your income falls below par.
Savings Account No. 2: Rainy Day Fund
This account would have the equivalent of at least three month’s living expenses and is responsible for handling bigger, unforeseen emergencies such as a major car repair or job loss.
Savings Account No. 3: House Down Payment Fund
This account would be the repository for your minimum home down payment, which nowadays can be anywhere from 5% for most people with excellent credit on up to as much as 20% for others.
Prioritizing the Funding of Your Savings Accounts
Now here comes the important part…
For this plan to work, it is of utmost importance that you prioritize the funding of your savings accounts. I have listed the accounts above from highest to lowest priority. That is, the Paycheck Shortfall account is the highest priority and the House Down Payment fund is the lowest priority. Before you put any money in a lower ranking savings account, you must first ensure that the higher priority account(s) are fully funded.
That’s it. Pretty simple, yes?
If you decide to get started on this plan, you should immediately fully fund your Paycheck Shortfall and Rainy Day accounts from your current house down payment savings. Then, in the future, whenever you are forced to draw down either your Paycheck Shortfall or Rainy Day funds you should immediately fully replenish those accounts from your House Down Payment savings account.
Of course, the trade-off in using this approach is that your savings rate for the house down payment will be reduced somewhat; in the short term it may even be negative. But your earlier faster savings rate was really illusory because to get that faster rate you had to accrue credit card debt.
By using multiple savings accounts to smooth your monthly income variations you will not only be free from ever again having to use credit cards to cover the bills, but you will also have an accurate gauge of where you really stand with respect to your progress toward owning that first home.
Then Again, There’s Always A Second Job…
And, Anthony, I agree with you. If I were in your shoes and I still couldn’t quite scrape up enough money for a house down payment quick enough I would rather get a second job than pile up credit card debt simply to avoid cannibalizing my down payment savings!
But that’s just me. I abhor paying interest. To anybody. For anything.
Best wishes and please keep me posted on your progress towards saving for that house!
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