Money Management

People who are never broke use money in certain ways. Here’s how you can embrace their tricks. 

Being broke, or not feeling like you ever have enough money, can be a frightening experience. It can cause a lot of financial stress.

The good news is, there are some habits you can adopt that will reduce the chances of ever finding yourself in this situation. Here are three habits of people who always have at least some money to spare.

1. Spending less than you earn

According to Pew Charitable Trusts, a shocking 55% of Americans either break even or spend more money than they make each month. If you are doing this, you’ll never get ahead financially.

If you want to make sure you’re never broke, you’ll need to find a way to either increase income or cut expenses so you can set aside money to have in reserves in case you need it. In general, you’ll want to keep your spending to 80% of your income or less while saving the rest to give yourself a financial cushion.

You can do this by:

Keeping fixed expenses low: Do not commit to ongoing expenses (like housing costs and car payments) that exceed 50% of your income. This may mean you need to live somewhere cheaper, drive an older used car, or get a roommate.Budgeting your money: You’ll need to allocate where your funds should go to ensure you aren’t spending all that you earn or even close to it. Give each dollar a job and make sure you’re being realistic by tracking spending for a while before making your budget.Prioritizing paying yourself first: Aim to transfer at least 20% of your money on payday into savings (for short-term goals) or retirement or brokerage accounts (for long-term goals).

2. Avoiding high-interest debt

Debt makes it a lot harder to avoid being broke in two ways:

It increases your costs: Anything you borrow to buy costs you more because of the interest you must pay. If you buy something that costs $1,000 and you pay cash for it, you pay $1,000 for it (plus tax, if applicable). If you buy something that costs $1,000, charge it on a credit card with an 18% interest rate, and make only a minimum payment equal to the lesser of $20 or 2% of your balance, it will cost you $2,396.76 before it’s paid off.It takes away your future income: If you commit to debt, you are reducing the future income available to you. Part of the money you earn each month must go towards past expenses. In the above example, for instance, you’d be making credit card payments for 151 months. When you use current income to pay for past expenses, you have less to spend on current needs, so you are more likely to need to borrow more.

A recent survey conducted by Ramsey Solutions found that 40% of people who are in debt indicated they were struggling or in crisis financially. This is almost double the 22% of people with no debt who said the same. If you don’t want to be broke, try to avoid borrowing money, except for low-interest loans that help increase your net worth (like a mortgage loan). You can save up for larger purchases or buy used to keep costs down rather than borrowing.

3. Maintaining an emergency fund

Emergencies are inevitable and they can leave you broke if you aren’t prepared for them. A Pew Charitable Trusts survey found that 60% of households had experienced a financial shock over the past year such as major repairs or an income drop. More than half (55%) said this shock made it difficult for them to make ends meet.

If you want to make sure you never end up lacking funds, aim to save money for emergencies in a high-yield savings account. You should build an emergency fund with three to six months of living expenses so unexpected costs won’t send you into debt (or leave you facing long-term financial damage such as a foreclosure or repossession).

To save up your emergency fund, save your windfalls (like raises or tax refunds), work saving into your budget by cutting expenses like dining out or gym memberships, or consider working a side gig until you have enough emergency savings.

You can adopt these habits of people who are never broke, and soon you may find yourself in a position where you have plenty of money to live on and the financial security that goes along with it.

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Getting approved for a mortgage may require you to show that you have enough money to cover the bills for a few months after closing. Here’s what you need to know. 

Getting approved for a mortgage can be a long and complicated process. You’ll need to shop around for a home loan, submit an application, and provide a ton of financial documentation to your lender. Your lender will then consider things like your income and credit score to decide how much you can borrow and what rate to charge you.

Your lender may also want to see that you have financial reserves before it approves you for a loan. But what exactly does this mean, and will this be a requirement in your situation? Here’s what you need to know.

What are mortgage reserves?

Mortgage reserves refer to money you will still have left that’s available to you after you pay your down payment and closing costs. Lenders may want you to have some money set aside that is easily accessible in case you need it to cover your mortgage costs if you experience a job loss or another decline in income.

Typically, mortgage lenders will require your reserves be in liquid assets, which means the money isn’t tied up and you could access it quickly should it become necessary. Examples of assets that could satisfy your reserve requirements include:

Money in your checking account or your savings accountsCertificates of deposit (CDs)Money invested in a retirement or brokerage accountCash value life insurance policies

The point is, the bank wants to know that if you take out a home loan and then something goes wrong, you aren’t going to stop making payments and end up in foreclosure.

Will you need money in reserve?

Reserve requirements can vary based on many factors, including:

The type of property you are purchasingType of loan you take outLender policyYour credit and incomeHow much you are borrowing

Your lender will tell you exactly how much you need in reserve. In general, though, you can expect that you may need around:

Two to six months for a primary residence that you will personally occupyTwo to four months for a second homeSix or more months for an investment property

If you are getting a government-backed mortgage loan, such as an FHA, USDA, or VA loan, reserve requirements can also differ. While USDA loans never require reserves and FHA or VA loans don’t require reserves for single-family homes, things are different with multi-family properties. If you are buying a three- or four-unit property, your lender may require three months in reserve for an FHA loan or six months for a VA loan.

When lenders calculate reserve requirements, the goal is to make sure you have the funds to cover your principal and interest on your mortgage, as well as taxes and insurance (PITI). So, if your total monthly mortgage payment, including all these costs, is $1,000 and you need two months of reserves, you would need $2,000 set aside in liquid assets after you close and pay all those costs.

It’s important to find out early on from your mortgage lender if you will need assets in reserve. This way, you can start saving money to make sure you meet this requirement and are ready with your home purchase.

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We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
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Incorporating a small business has many benefits, but there are also some downsides too. Here’s what you need to know to decide whether to incorporate. 

If you are running a small business, you have to decide how to structure it. Incorporating it is one option.

You could choose to form an S-corporation or a C-corporation, but many small business owners opt for an S-corp because it is a pass-through entity. That means the business itself does not pay taxes. Profits and losses pass to owners. C-corporations, on the other hand, do pay business taxes and owners pay taxes when profits are distributed so you risk double taxes (but you do get more flexibility in terms of who can own the company).

There are both pros and cons to incorporation as either an S-corp or C-corp, so be sure to consider both the advantages and disadvantages when deciding how best to run your business.

These are some of the biggest advantages of incorporation

Here are some of the biggest benefits of choosing to organize your business as a corporation:

You get liability protection. When you have incorporated your company, it becomes its own separate legal entity. It exists independently from you, which provides you with strong protection from liability. If someone sues the business or the company goes into debt or something else goes wrong, your personal assets will not be at risk — only the company’s will (as long as you kept your money separate).You have tax flexibility. If you choose to incorporate as an S-corp, you will operate as a pass-through entity. If you choose to incorporate as a C-corp, the business will pay taxes. Regardless of whether you operate as an S-corp or C-corp, you can opt to pay yourself a salary from the company and then take additional money out of the business as distributions or dividends. This allows you to avoid self-employment taxes on some of your earnings. You could also save money because certain other expenses can become tax-deductible, such as health insurance premiums.It’s easier to transfer ownership of your business. Since the company exists independently of you, it’s more likely to continue after you no longer want to operate it. You can sell or gift shares to others, giving them an ownership stake in the business. There is more flexibility in who can own shares of a C-corporation, but both S-corps and C-corps provide this benefit.

I run my business as an S-corporation because I appreciate the tax flexibility and the liability protections.

I was able to reduce my tax bill considerably by forming an S-corp, paying myself a reasonable salary that is less than the company’s total earnings, and then distributing the rest of my company profits to myself (and thus not paying Social Security or Medicare taxes on those distributions).

These are some of the biggest downsides of incorporating

There are also some downsides to incorporating as well.

There’s added paperwork (and cost). You will have to file paperwork to incorporate and often pay a fee to do so. And you may have to pay an annual filing fee to your state. In my state of Florida, for example, I must pay a $150 per year fee to submit an annual report for my for-profit company. I also have to employ a payroll service to pay myself my salary and pay fees to the state for things like unemployment benefits for myself — and you probably will too depending on your state’s rules. Your company also has to file a tax return, even if it is a pass-through S-corp, which adds accounting costs. And you’ll need to have annual meetings and keep corporate records.Taxes can be higher. If you are a C-corp, the business must pay taxes and you must also pay taxes when you receive a share of company profits, so you may be taxed twice. While this isn’t an issue for S-corps, some states also don’t have favorable tax rules for any corporations, so your tax bill can sometimes end up higher. This is not the case for me because Florida doesn’t charge separate taxes for S-corps, but it is in other states, such as Washington, which subjects S-corps to a business and occupation tax. You should check the rules with your state’s Department of Revenue.It can be harder to access your own money. You need to keep personal and business assets separate when you incorporate. If you are paying yourself a salary that’s less than your company’s profits, you may need to leave your money in your business accounts until you are ready to distribute profits. Doing this too often could cause a red flag with the IRS, which might investigate whether the distributions are just salary in disguise.

You’ll want to consider the advantages and disadvantages before you move forward with incorporating.

If you do decide to incorporate, you could talk to a lawyer to help you file the paperwork. You can also do it yourself, as your state generally will have the forms online you need to file. If you aren’t 100% sure of the legal or tax implications, though, or don’t know exactly what paperwork to file, getting professional help is likely your best move.

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We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

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