October 23, 2012

Protecting Your Take-Home Pay: Personal Finance Tips

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July/August 2009 Issue | Volume 35 Number 5 | Page 60


Protecting Your Take-Home Pay: Personal Finance Tips

There’s an old saying that you can’t fix the roof when it’s raining, but when it’s not raining the roof doesn’t leak. Lots of repairs don’t get made for just that reason. Similarly, when the economic picture is sunny and worries about take-home pay are nowhere on the radar, you don’t worry much about your finances. For many lawyers, alas, the situation is changing.

We are often asked how law firms can cut their expenses when business is slow, and it’s a question that’s been cropping up quite a lot lately. Unfortunately, there isn’t really a good answer—at least not one that firms want to hear. Any time you begin to trim expenses, you must be careful that your cuts don’t sever an artery, slicing off the income-producing capacity of the firm.

Still, if you take a look at any law firm’s expense statement, you’ll see that compensation and facilities costs account for the vast majority of ink. Facilities costs are almost always based on either long-term leases or mortgages, making them like the proverbial battleship: impossible to turn quickly. Which leads us to compensation. As we all know, the current recession has resulted in numerous law firm layoffs. Less frequently mentioned, however, are the reductions in salaries and partner draws that are being used as a strategy to lower costs while keeping a firm’s capacity for future growth intact. (See Jim Cotterman’s “Compensation Challenges” article on page 47 of this issue.) Those reductions aren’t a welcome change for those whose take-home pay is temporarily “downsized,” but it beats the unemployment line.

So if you find that you’re about to get a “haircut” without a visit to your favorite barber or stylist—or you’re a solo or small firm lawyer who is well aware that if you don’t make it you can’t spend it—here are a few tips you can use to put your personal -finances in order. They will help you to make the best of things now, as well as after the economy picks up again.

Ditch the Debt as Quickly as Possible

Getting out of debt and staying out of debt is basic financial common sense. Sure, but easier said than done, you’ll think, especially if your income is going down. So what can you do? In his book Financial Peace, Dave Ramsey recommends using the “debt snowball” to accelerate the debt-elimination process. Here’s how it works.

  • Make a list of all your debts, showing the balance, the monthly payment amount and the number of months left until the debt is paid off.
  • Rank the list from least to most number of months of payoff time.
  • Once you pay off the debt with the shortest remaining term, add the amount you had been paying each month on that debt to your payment for the next one so you pay it off early.

Once that debt is eliminated, add the monthly amount you were paying for the first two to ▪ the regular payment for the third debt and so on.

In this way you can greatly reduce the number of months needed to pay your outstanding debts. And as you see one debt after the other melt away, you’ll be encouraged to keep on keeping on (and to avoid the temptation to take on any new monthly payments) until you are debt-free.

Beware of the Rule of 78

Lawyers who don’t handle consumer financial transactions are often unaware that interest on auto loans and other loans for the acquisition of personal property is often calculated and repaid differently than interest on home loans. It doesn’t make much difference unless you want to pay the loan off early, in which case it can result in a substantial, albeit hidden, prepayment penalty.

Most old-fashioned mortgage loans are based on simple interest calculations. The principal amount is amortized over a stated number of years, so that as you make each monthly payment, you pay interest on the total amount of principal you owed during the previous month, plus you make a reduction in the principal owed. Each month, the portion of your payment that’s applied toward interest goes down and the portion applied toward your principle balance goes up as you chip away at the amount you borrowed, resulting in less interest due monthly and more of the fixed payment amount available to further reduce principal. When you pay the loan off early, unless its terms contain a prepayment penalty, you pay only the interest the lender has earned through the date of payoff, plus the outstanding principal due. Interest savings when you pay a simple interest loan early can be substantial.

However, loans that are figured using the Rule of 78 are different. This method allocates approximately three-quarters of the interest that the lender will earn over the life of the loan to the first half of the loan term. This means that the first payments you make are nothing but interest. If you’ve already made more than half the scheduled payments on such a loan, you will not gain much, if anything, in terms of interest savings by paying the loan off before its regularly scheduled maturity date. You should consider factoring this information into your debt-reduction plans.

Choose and Use Your Credit Cards Wisely

A number of lawyers with good credit ratings have reported that, despite those ratings, their banks have raised their credit card interest rates, lowered their credit limits, or done both. In this day and age, it is definitely worth your while to search out the best credit card deals. Fortunately, there are several Web sites that, in easy-to-review ways, will keep you current on what’s being offered. Check out these three:

Even if you are debt-free and only use a credit card to facilitate purchases and returns, paying the entire balance off at the end of each billing cycle, there is still a trick that you can use to reduce the amount you spend. Remember, studies have shown that people are much more likely to spend more if they put their purchases on a charge card rather than writing a check or handing over cash.

So here’s the trick: Try adopting a “register” for all your credit card purchases. Just as you would do when recording a check in a regular checkbook register, you enter this information whenever you use your credit card: the date of the transaction, the seller and purpose of the charge, and the charge amount. Keep the total spent up to date, and then any time you’re getting ready to charge something, you’ll be able to tell how much you’ve already charged that month—and whether you are within, or over, your pre-established budget. You’ll also have a handy reference that will help you spot any unauthorized charges when you review monthly statements.

Protect Your Financial Foundation

As a final but very important point for this installment of our column, we urge you to be careful about maintaining good insurance coverage, regardless of wherever else you are looking to trim the budget. Based on some recent statistics, the majority of non-business Chapter 7 bankruptcies have been the result of catastrophic medical bills. Many involved middle-class people who had lost good jobs, and lost their medical insurance as a result.

That’s why it’s a good idea, when you are evaluating personal expenses during tight financial times, to review and evaluate your health insurance coverage, particularly your disability insurance, to make sure that you are getting what you need. (You can find information on medical insurance carriers and rates, as well as small business and COBRA health insurance alternatives, at www.ehealthinsurance.com.) When you could make a monthly disability insurance payment for the same amount as those extra cell phone lines or cable TV, is the choice of what’s most important really that hard?

About the Authors

David J. Bilinsky is a practice management consultant who focuses on enhancing law firm strategy, finance and technology initiatives. Laura A. Calloway is Director of the Alabama State Bar’s Practice Management Assistance Program.