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8 Steps to Get Your Financial Life in Order

Do you have "frugal fatigue?" You're not alone. Pinching pennies becomes exhausting, year after year. You dream of breaking free and buying everything in sight.

But tiresome as budgets are, consumers haven't quit them yet. You threw some money around in December, when credit card use bumped up for the first time since the 2008 financial collapse. Then remorse set in. Consumers slashed their credit-card spending in January by 6.4 percent at an annualized rate, the Federal Reserve reported this week.

That fits with what the National Foundation for Credit Counseling is seeing on the ground. In a recent NFCC survey, two-thirds of consumers said that they're sick of having to question every dollar they spend, but have no choice. Incomes are virtually flat, employers aren't calling the long-term jobless back to work, and the cost of critical purchases such as health insurance and gasoline are leaping up. Only 5 percent of the people questioned said that they couldn't stand to keep living under fiscal restraint, and intended to spend more. About 8 percent said they didn't need to be particularly frugal. They hadn't cut spending and were doing fine.

The rest -- about 20 percent of the consumers -- overcame their frugality stress in the old fashioned way: they changed their lifestyles so they could live comfortably within the incomes they had. They found this new life so positive that they said they'd never go back, reports Gail Cunningham, a spokesperson for NFCC.

If you're sure that your financial troubles are temporary, it pays to pinch the pennies until the dollars start rolling back in. But the story is different if you see little hope of raising your income by enough to make your current expenses each to cover. Emotionally, making big changes is hard to do. But the faster you reinvent your life, the more money you'll have in your pocket and the sooner you'll be able to save again.

Your two largest expenses are probably your home and your consumer debt (plus health insurance, if you're not on a company plan). Your first step is to quit adding to debt -- put your credit cards on deep freeze and pay bills with cash or a debit card. Then follow these steps:

1. If you live in an apartment, check comparable rents in your neighborhood. They've dropped in many parts of the country. If you find that you're paying more than the market requires, show your landlord proof and ask for a rent reduction. If the answer is no, move.

2. If you own a home and it's salable, sell. Put any net gain into savings and investments, and find an apartment to rent. You'll be saving the high cost of maintaining a house, as well as tax and insurance bills.

Don't hold onto a house because you think you "need" the mortgage interest deduction. Financially, you're far better off without it. As an example, say that you're paying $1,000 in interest, in the 25 percent tax bracket. The taxpayers cover $250, leaving $750 as your net cost. Now imagine that you have no mortgage and $1,000 in income. You'll pay $250 in taxes, leaving you with $750 in your checking account. Losing the mortgage gives you more money to spend.

3. Restructure your credit card debt. Move some of it to a new card with a zero-rate promotional offer. Don't use that card for purchases right away. Instead, concentrate on repaying this debt within the promotional period. You might also move debt from a high-rate card to one that's charging a lower rate.

4. Start a debt-repayment avalanche. Get the latest bill for each of your credit cards, to see which one is charging you the highest rate (some cards have two rates, one higher than the other). Pay the minimum on the lower-rate cards and put all the rest of the money toward knocking off the high-rate debt. When that card is clean, move on to the next one.

Some people prefer to start by repaying the card with the smallest debt, even if its interest rate is low, for the pure pleasure of eliminating an annoying bill. Do whatever works. But you'll get the most bang for the buck by tackling the high-rate card first.

5. If you have savings, put all but a token amount against credit card debt. Keep only $500 or $1,000 for unforeseen expenses. Consumers often don't realize the enormous return on investment they get from cleaning up their credit cards. For example, say that you're paying interest at a rate of 18 percent. Every payment you make against that debt gives you a guaranteed 18 percent return on your money. If you're paying a penalty interest rate of 24 percent, every payment equals a 24 percent investment gain. Where else could you get a yield like that, and totally safe?

6. If you have money in a 401(k) retirement plan and your job is safe, consider borrowing against it. In theory, I consider these plans inviolable -- never to be touched. In practice, it makes sense to use them if they can help you rightsize your life. The transaction will look like this:

You'll borrow from the plan at 1 to 3 percentage points over the bank prime rate, which is currently 3.25 percent. So the loan might cost you 5.25 percent. You'll repay credit card debt at 18.25 percent, for a 13 percent gain. Typically, you'll have to repay the 401(k) loan over five years, with the payments deducted from your paycheck automatically. The interest you pay goes right back into your account, so you're paying t to yourself.

There are two financial downsides. First, you're repaying the loan with after-tax dollars. When you eventually take money out of the 401(k), those dollars are taxed again. But you're probably still ahead, thanks to the savings on your credit card bills. Second, you'll lose any appreciation that would have accrued to the money you borrowed. You can minimize this risk, however, by arranging to borrow against only the bond portion of your plan, leaving the stock portion exposed to any gains.

If you leave your job, and part of the loan is still outstanding, you'll have to repay it right away, in full. If you can't, the remaining loan will be treated as a withdrawal. You'll own income taxes on the money and a 10 percent penalty if you're younger than 59 1/2. So this loan is for someone who is pretty sure that his or her job is safe.

7. If you're one of the lucky 78 percent of homeowners who have equity, you could -- potentially -- pay off your credit card debt with a new home equity loan. But the argument isn't as compelling as it is for loans against 401(k)s. Ideally, you're aiming for a paid-up home when you retire. That will cut your cost of living, give you access to a reverse mortgage for extra cash, and provide money needed for long-term care. A home equity loan might make that impossible.

8. If you don't have health insurance, any major illness could put you into bankruptcy. Try for a high-deductible policy, or see if you (or your kids) qualify for Medicaid or the children's program, Schip. If insurance companies won't take you because of a medical condition, try for a place in the high-risk pools set up by the new health reform act. We're a long way from equal access to medical care, let alone care at an affordable price. But if you cut other expenses, you just might be able to afford good health.

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