Sinking funds. Why you need at least one and how to do it.

Do you ever wonder how people afford to get home projects done? It can be a bit of a mystery and I know that a lot of our friends were wondering how we did so much to our house as soon as we moved in. We also did as much work as we could ourselves, instead of paying for everything to be done for us. That’s a story for a different day.

Most people will turn to their bank, I am not a financial advisor and you should always speak with your financial advisor before making choices related to large sums of money. This is just what I do, and may not be the right financial choice for you.

Let’s start with the basics.

How do you use a loan for home renovations?

You can take out an equity loan or credit line if you have equity in your home. Equity is the difference between what is owed on the mortgage loan and the home's current market value. That means that if you just bought your house and only put 3% down (also, eeek!) there’s not much available. So, you may have to adjust your expectations and not get that kitchen reno as soon as you thought. We will get to down payments another day.

It’s important to understand that borrowing more money from the bank is essentially taking out a second mortgage. Even if you don’t have to pay interest on it right away it will come due and you have no idea what your financial circumstances will be when that day comes. What if you get laid off the month before those payments kick in?

Or you could create sinking funds.

Let’s say you already have an emergency fund, but if you are anything like me you actually never want to use that money for anything. So, when a large expense comes up you could think yea I have room to pull from my emergency fund but then you feel guilty, or worry about what happens if an emergency comes up.

What is a sinking fund?

Sinking funds are savings accounts earmarked for specific things you know you will pay in the future, like property taxes, vacation or a home repair. They are not emergency funds.

How does a sinking fund work?

Simply take the amount you know you will need and divide it by the number of months until you need it and save that money every month in a separate high yield savings account. That way when the time comes you can relax that you have that money set aside and you don’t feel guilty for using it.

Sinking funds are also a great way to rethink your finances and help you understand what you can and cannot afford.

The first sinking fund we ever created was for our down payment. We didn’t even know it was a sinking fund, but we put a specific amount of money in a high yield savings account every month with a goal in mind. Once we hit that goal we were ready to put offers in. After we started looking at houses we realized anything in our price range would require renos, so we cut our available purchase price down by 20%. Our real estate agent was not happy with us, we started looking at houses in one price range and then said, actually show us some cheaper options. That way we knew we would have extra money available for renovations. This also meant that we had to broaden our search area and be open to neighborhoods a little further away. Which actually turned out great!

Once you are a homeowner sinking funds become very useful. For example, you know that your roof is 15 years old and it may have 10-15 years left. Using the estimate we just received for our roof, you could set aside $125 a month over 10 years and have $15,000 ready to pay for your roof in cash when the time comes. Doesn’t that sound better than the “holy shit we need to replace our roof where are we going to come up with $15K?!”

Sinking funds aren’t just for homeowners. You could create one to help offset childcare costs before you even have a baby. Save for a sabbatical. Or save for a big vacation.

The point is to have that money ready to go so you aren’t worried about paying off debt from that vacation for months or years later and getting stuck with all of that interest to pay.

Here’s a list of sinking fund ideas

• Property taxes: We don’t put ours in an escrow account, they earn interest for us, not the bank all year long.

• Appliances: You know you have at least one appliance that is on it’s way out, or one that you want to upgrade.

• Furniture: You moved all of your random old furniture into a new place and want to systematically upgrade.

• Vacation: There is something exciting about a vacation fund, it actually gives you something to look forward to.

• Taxes: Does April 15th stress you out every year? It doesn’t need to.

• Large home upgrades: New HVAC, roof, kitchen renovation etc.

• Childcare: Shit is expensive, that’s all I need to say here.

• Car repair or replacement: I can’t be the only one annoyed to ever spend money on a car.

• A big-ticket splurge: This can be anything that you have always wanted, just make a plan for it.

How many sinking funds do you need?

The depends on your income, but I like to use a general rule of how large of a purchase can you make without impacting your day to day. If someone asked you for a check for $100, $500, $1K, $5K etc where is your comfort zone? Anything above that amount should have a sinking fund.

What sinking funds do you start with?

Frankly, once you make a list and see how much money it will be every month it can get really overwhelming and you may want to stop, don’t stop. Just pick one or two. Personally, we started with things that cannot go on a credit card without incurring extra fees. Property taxes are a great one for this, yes technically you can put property taxes on a credit card (please don’t), but they usually charge you a 3% processing fee PLUS all the interest it will acrue.

Another great way to kick start sinking funds is with a bonus if you are lucky enough to get one. I know that most of my friends look at bonuses as a way to treat themselves. I don’t find a new purse a treat, I am in the minority that finds financial security a treat. So, I start there and then treat myself if there is money leftover.

Where do you open a sinking fund account?

Go for the highest interest rate with whatever other requirements you prefer. Usually, the highest rates are at online only banks, if this stresses you out, find a bank that is best for you. We use a credit union that also allows us to have several named sub accounts within our savings. It’s perfect for us.

Do you have a sinking fund? Or have questions? What are your favorite tips and tricks? Share in the comments below.

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