If you are going to embark on the journey towards financial freedom, you must learn to plan. Planning encompasses more than just understanding your recurrent monthly expenses. You must understand all of your expenses whether they are fixed, variable, monthly, annual, etc. During budget setting, it’s easy to forget the annual, semi-annual expenses, and non-monthly expenses. It happened to me today.
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I was looking through my email, and I saw a renewal notice from my car insurance company. I pay my car insurance semi-annually because of the “pay-in-full” discount. By paying in full, I save about $100 every six months. Although this is a sound strategy, the problem is you have to put the money away! Six months ago, I decided to set up a separate bank account that I would deposit money in monthly so the semi-annual bill wouldn’t be a shock. The strategy was good, but there were two problems with how I handled this:
- I was underfunding the account because my monthly payment assumed that I would make 6 payments, but I didn’t start saving right away
- I would tap the account if I overspent and needed more money. Literally I just took $100 from the account 4 days ago to make sure I didn’t risk over drafting my checking account because of my recent shopping spree.
Now I have two choices to make:
- Pay with a credit card
- Do a monthly payment plan
Here’s how I evaluated this decision:
Option 1:
If I charged my car insurance, in order to pay it off in 6 months, before my next payment was due, I would have to pay $180/month and it would cost me $49 in interest. This would reduce my pay in full savings from $100 to $51.
Option 2:
The monthly payment option is $100 more expensive, but the monthly payments are $186/month, which is only $6/month more than Option 1.
The options are pretty close with a slight edge to Option 1. The difference between the two is a savings of $51 semi-annually and $6/month. Other factors to consider are:
How much does this affect cash flow?
I was already saving $190/month towards my car insurance, but the problem was that I was occasionally using it to cover overspending. Therefore, the full amount was unavailable.
Alternatively, it is nice to have the option to be able to redirect my cash if I needed to – emphasis on the word need. Expenses always pop up, and it is nice to have the extra cushion if the need arose. The key is that I have to have the discipline to execute this strategy.
What is your available credit?
Your available credit affects your credit score. The lower your available credit, the % utilization of your credit card, the lower your credit score. Generally you don’t want to use more than 30% of your available credit. If charging would put you close to your limit, you risk damaging your credit score.
I decided to go with Option 1 mostly because of the cash flow implications. However, starting immediately, I am going to set up an automatic payment to pay off the insurance payment on the credit card in 6 months. I recognize that I will have to charge my insurance next month, but at least it is planned. Ultimately, the biggest thing that I’m working on is managing my spending so I do not put myself in the situation where I use an account earmarked for something to cover overspending.