Budgeting means less for fun and fashion

Holly Lesmeister and her friends often talk about how they're broke. "It's sort of like, none of us can ever see ourselves digging our way out of debt," says the 30-year-old, who lives in Minneapolis. "So, are we going to be deprived of the good things in life because we are going to spend the next 30 years being frugal, or are we going to have the good things in life but tolerate the annoying credit card debt?"

Now that she's $64,000 in debt and making about $35,000 a year, the graphic designer is attempting to live frugally.

To help narrow the gap between her income and debts, the Star Tribune teamed Lesmeister with Echo Huang, a certified financial planner at the Advocate Group in Minnetonka.

Huang usually meets with wealthier clients. But she is quick to point out to Lesmeister that debt does not discriminate and can plague workers with six-figure paychecks too.

At their first session in late August, Lesmeister tells Huang a little about herself while her new adviser scans the student loan documents and financial questionnaire prepared for the meeting. Student loans: $50,000. Credit card debt: $14,000. That and a dream that in five years she'll own a home, a business and be taking European vacations.

Huang punches numbers into her calculator. "I would not even be eager to buy a home," she tells Lesmeister. "I can just tell you that there are a lot of expenses related to a home that now you can't even imagine."

Lesmeister will afford her own home someday only if she increases savings or cash flow, and even then, a 20 percent down payment that Huang recommends is eight years away. Deep down, Lesmeister knew that advice was coming, and later on she cancels her appointment with a mortgage broker.

Following Huang's schedule, Lesmeister would pay off both higher-interest student loans -- at 9.75 percent and 8 percent interest -- in three years. Then she'd shift those payments into savings for a down payment on a home. She could buy sooner if she chooses to put less money down -- about 43 percent of first-time home buyers last year made no down payment -- or if she marries.

It's sobering for Lesmeister to hear there's no condo in her foreseeable future, but having an actual target date feels better than worrying she'd never afford to own. "At least eight years is eight years," she said. If she follows Huang's suggested budget, her credit card debt will be paid off by March 2013. Her 5.25 percent student loan -- $30,000 -- will be paid off in 2028.

Lesmeister doesn't look forward to following Huang's advice. Paying down her sizable debts means downgrading her lifestyle.

Here's the tough medicine:

Alter spending. Huang recommends $150 a month for clothes, half of Lesmeister's current spending, and $250 a month on food and fun, down from $400 now. "Besides food and clothing, I don't see she can cut much," Huang says later. Put the money saved toward the debt with the highest interest rate first -- her private student loans. Huang says to pay those before her credit card debt because the card has a fixed rate of 8 percent and is in her mother's name, although Lesmeister is responsible for the payments.

Lesmeister worries about missing out on fun. Friends mentioned checking out the new Jean-Georges restaurant in the Chambers Hotel in downtown Minneapolis. "You just can't go cheaply," she says, predicting she'll stay at home more rather than lower the caliber of places she frequents.

Huang suggests Lesmeister share her financial goals with her friends so they can support her efforts. Who knows -- they might feel relieved if she steers them toward affordable activities like bet-free poker or hiking in the woods. Lesmeister doesn't respond much to the suggested pastimes.

Get a part-time job? Huang is reluctant to suggest one based on Lesmeister's experience. She'd recently worked at a restaurant part time on Saturdays and felt she had too little time to regroup before the work week. But without a part-time job, it will take her more than a decade to pay her debt and buy a home. With extra income of $6,000 a year, her $20,500 in high-interest student loans could be paid off within three years.

Lesmeister's job schedule makes it tough to fit in more work. She recently worked until 10 p.m. assembling invitations for a client. But she does do freelance work as much as possible, recently designing a website for a photographer.

Start a Roth IRA. She saves $60 per month in her company's 401(k) retirement plan, but unlike most employers, hers doesn't offer matching money. Failing to invest in a 401(k) plan that does offer a match is like leaving free money on the table. But for workers whose employers don't match, a Roth IRA, or individual retirement account, sometimes is the better choice.

Huang suggests she direct $150 into a Roth each month and increase contributions by 3 percent with every raise. A Roth is funded with after-tax money, meaning "at the end, that money is what you can spend -- you don't have to pay taxes," Huang explains. She prefers the Roth because she predicts that taxes will be higher in the future, making it better to pay tax at today's historically low tax rates. Plus, Lesmeister is in a low tax bracket today.

Lesmeister worries that saving for retirement first "seems flip-flopped." But the numbers are convincing. If she saves $1,800 a year in a Roth and increases that amount with each raise, Huang calculates she'll have close to $600,000 when she turns 65, assuming the market returns 9 percent a year. Without a Roth, Huang figures her client can buy a house 15 months sooner, but will have little for retirement.

The other nice thing about the Roth? Lesmeister can take any money she contributes out of a Roth IRA without being taxed or penalized, as long as she keeps the interest earned on that money in the account. After five years, first-time home buyers can take out $10,000 tax and penalty-free whether it's principal or interest.

Save for today. Huang wants Lesmeister to save for immediate needs, putting $50 a month in a high-interest savings account with an institution like online savings bank ING Direct, which currently pays 4.4 percent. That would ensure that car repairs or other irregular expenses don't go on a credit card. She also should be saving now for next year's weekend trips. Traveling through Nicaragua and Costa Rica contributed to Lesmeister's credit card woes. Huang suggests automatic monthly transfers from checking to savings.

Making the first return

Within weeks, Lesmeister is at Macy's Southdale store on a mission that would make Huang proud: returning tan boots she had bought on a credit card before reading through Huang's recommendations. She worries that last year's black boots won't do. "I can't help what fashion dictates," she says. "This year it's tan." But she returns them anyway. The new fall ensemble forming in her head -- wool city shorts, plaid leggings, and a pair of heels -- stays there. She leaves the store empty-handed, but with a credit of about $60 on her plastic.

Tomorrow: Malinda Erickson, a recently divorced mom, tries to change her spending habits with a money mantra.

Kara McGuire • 612-673-7293 Read Kara's blog: www.startribune.com/kablog • kara@startribune.com